Tax time is here again in the US and many Americans are expecting to receive some kind of tax refund. In 2016, the average refund was $3,159. There are many debates whether or not you should give the government a “free loan” of your money throughout the year, but I subscribe to the “you do you” school of thought on this. If you have better plans for your money month by month, adjust your withholding accordingly. If you like having a lump sum once a year to do something with, then keep on. Personal finance is personal.
If you are going to receive (or already have received) a tax refund, here are some of the best ways to use it.
Pay Down Debt
The average household has $16,748 in credit card debt with an average interest rate of 15.07%. That can mean over $200 of the $669 payment is going to interest each month and not even reducing the balance. It would take 13 years 10 months to pay off that debt. With interest added in, you’d pay a total of $24,319.
By putting the average tax refund towards credit card debt, it would shave 7 months off of repayment. That may not seem like a big deal, but the total paid would go down significantly-to $19,714. And that is if you only put one year’s tax returns towards debt and nothing else!
The best thing you can do for your future self is eliminate debt payments and keep more of your hard earned money in your own pockets, not those of creditors.
Fund Your Retirement
The second best thing you can do for your future self is make sure there is monthly income waiting for you when you retire. $3,000 won’t max out your IRA for the year, but it will help make a big dent in it! The earlier you save for retirement, the more you can generally count on compound interest to help you. The average American aged 55-64 only has $104,000 saved for retirement. If you saved $3,159 each year for 10 years, and averaged a 4% return, you’d have $39,444. That’s a $7,854 increase! If you save $3,159 for 25 years you come out with a total of $136,822, and increase of $57,847.
Make a Home Improvement
If you don’t have debt, and your retirement is already on track, then making an improvement to your house might be a wise decision. Your house may very well be your biggest investment, and if part of your retirement plan is to downsize, then making improvements that add value at resale time might be a good investment.
Admittedly, $3,159 does not go very far in a renovation. But it is enough to buy new kitchen appliances, landscape to add curb appeal, or updating light fixtures, outlet coverings and adding crown molding.
Of course there is nothing wrong with putting your tax return towards larger projects. Making cosmetic (and not structural) upgrades to your kitchen and bathroom can recoup 98-102% of the cost you put into it!
Rainy Day/Emergency Fund
Even though I don’t have a dedicated emergency fund, I am a big believer in saving for unexpected expenses. Maybe you’ve had many unexpected expenses recently and your EF has taken a hit. Maybe you have annual insurance bills coming up and you get a discount if you pay in full. The third best thing you can do for your future self is make sure that you can face any emergency with minimal stress.
No debt? Retirement on track? Don’t want to put any more money into your house? Emergency fund in tact? Do you have kids, and want to help them pay for college? Then consider a 529 plan. The money placed in a 529 plan grows tax free as long as it is used for qualified college expenses. Some states even offer additional tax incentives to use 529s to save for college. Here are some benefits of saving in a 529 and here are some negatives of using the 529. If you go this route, make sure to research the particulars for your state, and evaluate the alternatives for your family’s situation.
Did you receive a tax refund this year? How did you use it.