7 smart ways to use your tax refund
By Allie Johnson
April 3, 2014
You're done with your taxes, and it's time for the big payoff: your refund. Instead of blowing that wad of cash on a dream vacation, a new wardrobe or the latest gadget, how about using it to shore up your finances?
Many Americans plan to do exactly that: A 2014 survey by TD Ameritrade shows that 61 percent of taxpayers expecting a refund from the IRS plan to save or invest that money, while 21 percent will pay off debt.
So, what are the best ways to use your tax refund to increase your financial security? Here are seven smart options:
- Pay off your credit card debt. The average credit card debt was $7,145, according to Demos' 2012 National Survey on Credit Card Debt of Low- and Middle-Income Households. And the national average APR on new credit card offers is 15.01 percent, according to CreditCards.com — though, of course, some cardholders pay much more. Paying off high-interest debt is one of the best ways to use a tax refund, says Lance Cothern, founder of the personal finance blog Money Manifesto. For example, if you use the lump sum to pay off a $3,000 credit card balance with a 20 percent interest rate, you keep the almost $600 you would have paid in interest over a year if you only made the minimum payment. “High-interest-rate debt should be a top priority since it's essentially a financial emergency,” Cothern says.
- Shore up your emergency fund. What if your transmission goes kaput, your basement floods or your kid breaks a bone? Only 66 percent of Americans have enough money saved to handle these types of emergencies, according to the National Foundation for Credit Counseling. In fact, 31 percent have no emergency savings at all. “If you have absolutely no savings, put some of your refund in the bank as a buffer for emergencies — even if it's only $1,000,” says Steve Stewart, a financial coach and personal finance podcaster. Then put the rest toward debt, he recommends.
- Help pay for your kid to go to college. If you don't already have one, consider setting up a 529 plan, a tax-advantaged plan that can be used to pay for expenses such as college tuition, room, board and books, says Lule Demmissie, managing director of retirement at TD Ameritrade. These plans have many advantages — including the fact that others can contribute to them, too, she says. “In the old days, grandparents used to get treasury bonds or buy a stock for their grandchildren,” she says. A 529 plan offers a convenient way for today's grandparents to pitch in toward a grandchild's college education.
- Stash more away for retirement. A lump sum tax refund can be a good way to put a little more aside, Demmissie says. If you have an individual retirement account (IRA) and haven't reached your maximum contribution for the year, she recommends adding all or part of your tax refund up to that amount. If you don't have one, decide which type of IRA is best for you — a Roth IRA can be a good option for those who qualify, she says — and open one. People are living longer, and a 401(k) through work might not be enough: “You need to make sure you have a little extra saved up so you don't run out of cash,” she says.
- Boost your earning power. Putting your tax refund to use to bolster your professional skills can give you a big return on your investment, says Cheryl Palmer, owner of the executive coaching and resume writing firm Call to Career. You might look into getting a professional certification, she says. This could give you an edge if you're trying to land a promotion or job, she says.
- Spruce up your house. Address a maintenance issue — for example, replacing an old water heater or dilapidated roof. “You're preventing future costs,” says Demmissie.
- Beef up your insurance. Many Americans lack adequate insurance coverage in several areas, says Amy Bach, executive director of the insurance consumer advocacy group United Policyholders. For example, victims of natural disasters such as wildfires and tornadoes often don't have enough insurance money to rebuild their homes, Bach says. She recommends using part of your refund to buy an extended replacement cost endorsement, an addition to your home insurance policy that helps to ensure that you have enough money to rebuild your house, even if your coverage limits aren't high enough. “That shouldn't cost more than $500,” Bach says. Then consider buying — or increasing — disability insurance or life insurance, she says.
Overall, Cothern recommends using a tax refund just as you would any other income. And if you're tempted to blow the money on something frivolous, think twice, he says. “If you couldn't save for the same item out of your paychecks without the tax man holding onto your money, you might need to re-examine your spending habits.”