Smart Money Moves to Make With Your Tax Refund

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Point of Interest

If handled wisely, a refund can be an early-year boon for consumers looking to invest or pay off high-interest debt.

An income tax refund may seem like the perfect excuse to book a vacation, but it may just be the stimulus you need to crawl your way out of a messy or complicated financial situation. Figuring out what to do with a tax return refund is one of the fundamentals of personal finance, so if you don’t know what to do with your tax refund, try using it to set yourself up for future financial success.

Why am I getting a tax refund?

You are getting a tax refund because you paid the government more in taxes than you were liable for. For most of us, this means too much money was deducted from our payroll. If you’re a freelancer, it means you overpaid on your estimated taxes.

How does a tax refund work? 

 When you get a tax refund, it means that you paid more in taxes the previous year than you were liable for. If you had $4,000 in total taxed from your paychecks but you only owed $3,000, then the government will refund you the remaining $1,000. 

Also, if you paid less than your tax liability, you may owe money, which should be paid back as soon as you can to avoid costly fees and penalties. On the other hand, if you didn’t get a tax refund or owe money, it means that you paid the exact amount of taxes that you were liable for. It doesn’t mean you’re losing out on money; in fact, your checks are larger than they would be if you withheld more and received a tax refund. 

If you want to adjust the money being withheld from your paycheck, ask your employer to update or re-submit your W-4. 

What not to do with your tax refund

Remember that your tax refund is your own money finally finding its way back to you. It’s not a bonus nor is it a reward from the government. Don’t use it for anything you would feel foolish spending your paycheck on.

Here are some specific things not to spend your refund on:

Don’t book a spontaneous vacation

There is nothing wrong with taking some time out to relax and see the world. However, there is something wrong with splurging your tax refund check on a last-minute vacation. If you want to take a trip, take your time to plan it out and don’t book the most expensive options just because your tax refund check has arrived in the mail.

Don’t buy a bunch of stuff you don’t need

When your tax refund comes in, things that are in perfectly fine shape may start seeming a little out of date. For example, you might begin to notice how your office chair squeaks or maybe your T-shirts are looking a little faded. Don’t fool yourself into squandering all of your refund on material goods.

Don’t just stick it in a checking account

Unless you adhere to the strictest of budgets, putting your refund away in your checking account will make it too easy for you to spend. It can become easy to swipe your card for unnecessary purchases when that money is sitting in an accessible account. Not to mention your money won’t be growing when the least it could be doing is earning you interest in a high-yield savings account or IRA.

What to do with your tax refund

You should use your tax refund to improve your financial security. There are a lot of ways to go about it. Here are a few ideas to get your started.

Pay off high-interest debt

Use your tax refund to pay off high-interest credit cards or personal loans. It can be hard to pay off huge chunks of debt without disrupting your cash flow or getting in the way of your various monthly bills. That’s why a tax refund can be a boon for anybody struggling to free themselves of a debt cycle.

Start an emergency fund 

Everyone should have an emergency fund. It’s the stash of cash you turn to when life goes south. You don’t have to put your whole tax refund toward your emergency fund — save all of it or just a portion of it. It may not be the exciting thing to do but you sure won’t regret the security it affords you down the line.

Save for a down payment on a house

Most people take out a mortgage to buy a home, but they still need cash to cover the down payment and closing costs. That’s not to mention the monthly cost of the mortgage. This can be a major obstacle to buying a house, however, one or two tax refund checks may go a long way in securing your future home. 

Make home improvements 

If you already own a home, you can use the money to make any overdue repairs or a face-lift to increase the home’s value. Consider replacing old, inefficient appliances, like a faulty fridge or energy-sucking laundry machines. This could save you on your utility bill while also reducing your carbon footprint.  

Save for retirement

If you don’t already have a retirement account set up through your employer, a tax refund gives you the perfect opportunity to start one. Most investment firms have no account minimums, so you can start a Roth or traditional IRA with your tax refund, no matter how small it is.  Once again, you don’t have to deposit the whole check, but you should be regularly contributing money to your account if you want to take advantage of compounding interest. You can also consider putting it in a high-yield savings account if you want to earn some interest while keeping your cash fairly liquid.

Start your own business

It takes money to make money. If you’ve been sitting on an idea for the next Fortune 500 company, this may be the shot you need to launch your business off the ground. This doesn’t mean you should throw your money at the first venture that pops into your mind. Take some time to brainstorm your passions and figure out what kind of brand you’d like to represent. 

The final word 

While it may be tempting to use a tax refund to fund a fun vacation or buy a new TV, it’s important to know what to do with a tax refund that will benefit your life in the long run. Before going on a shopping spree with that refund, consider other financially responsible ways to spend your tax refund. 

Bents Dulcio

Personal Finance Contributor

Bents Dulcio is a personal finance writer based out of Orlando, Florida. His work has been featured in Debt.org, InCharge.org and elsewhere.