Tax season is never fun. Whether you file yourself or pay an expert, there can be hours of preparation involved. You have to compile your W2s, 1099s, and other sources of income. Expenses throughout the year need to be categorized and analyzed as potential deductions. Two hours into the process, you’ll swear to be more organized next year.
If you’re self-employed or a small business owner, the workload goes up immensely. Once you’ve done all the preparation for your business, you get to do it again for personal taxes. By the time you’re halfway done, you’ll be wishing you could pay extra just to make it stop.
The only bright spot is getting a refund. Everyone likes a surprise lump sum, and it feels even better coming from the government. While recent tax law changes have been controversial, the average refund for 2018 was similar to 2017. When the check arrives, it’s tempting to have some fun. Maybe you’ve had your eye on a new TV. A weekend getaway might be calling your name.
Unfortunately, most of us have better uses for the money. Before you blow your refund on an impulse purchase, consider a few of these smart ways to use it.
Add to Your Emergency Fund
Life is full of unexpected expenses. Cars break down. Health and dental emergencies happen. You could lose your job without notice. Sadly, one in four Americans has no savings and only one in five have a big enough emergency fund to cover three months of expenses. It can be daunting to contemplate saving several thousand dollars, especially if you’re living paycheck to paycheck.
A tax refund is a perfect starting point to break that cycle. Many high-yield savings accounts offer interest rates over 2%. If you open an account with a starting balance of $1000 and commit to adding $50 every month, you’ll end up with over $4250 after five years. The return isn’t huge, but it’s better than stuffing cash under your mattress. More importantly, you’ll have peace of mind if a financial emergency strikes.
Pay Down Debt
Consumer debt in America is higher than its ever been. Between credit cards, mortgages, student loans, auto loans, and a variety of other obligations, most of us have monthly payments weighing us down. Worse yet, there’s some sort of interest attached to these debts. Mortgages and auto loans generally have a relatively low-interest rate, but student loans can be at a variety of rates and credit cards are frequently over 15% APR.
Putting a lump sum towards debt is a great way to reduce your financial burden and gain peace of mind. It’s best to review all of your debts before deciding which to pay down first, but in general, credit cards will be the top priority due to their high-interest rates. Paying an extra $1000 with your next bill can shave months off of the time to pay a card down and save hundreds of dollars in interest.
Contribute to an IRA
If you’re debt-free and already have a healthy savings account, funding your retirement is the next logical step. Even if you have a 401k or pension through your employer, funding an IRA is worthwhile. Stashing away extra money will ensure you live comfortably in the future, and possibly retire at a younger age. Depending on your yearly income and the type of IRA you select, it might have tax benefits as well.
Additionally, IRAs offer a far more extensive selection of investment options than most corporate plans, many of them with lower fees. You might not be able to fund your entire contribution with your tax refund – the annual limit is $6000 if you’re under 50 – but it’s a great head start.
Spend on Home Improvement
Is there a project around the house you’ve been putting off? Or perhaps an old appliance that should’ve been replaced months ago but hasn’t entirely broken yet? Using a tax refund to address home improvement isn’t just a good use of money immediately, it can also save money over time.
For example, replacing an old refrigerator with a newer, more energy-efficient model will cut your monthly energy bill. Replacing old windows or insulation can save on heating and cooling costs if you live in parts of the country with severe weather. Even a project as minor as expanding a garden to grow food or replacing irrigation to save water can pay huge dividends over time.
Invest in a 529 Plan
The cost of higher education has been steadily rising for years, and that trend shows no signs of slowing. As the burden of paying for college has become greater, more and more parents are using 529 plans to prepare for their children’s education. While details of the programs vary by state, the core purpose remains the same – contributions to the investment plan grow over time and can be used down the road for college expenses including tuition, fees, and housing.
While the tax benefits of 529 plans can be complicated, most families will see a benefit from investing. One of the few downsides of the plans is that if the funds are withdrawn for a purpose other than higher education, fees will be assessed and could end up causing an overall loss. Consulting a financial advisor is encouraged before opening a 529 plan, but it can serve as an essential nest egg for your children’s future.
Treat Yourself
“All work and no play makes Jack a dull boy.” Tending to your financial health is important, but so is enjoying life. Once you’ve addressed savings, debt, and planning for the future, take a chunk of your refund and have some fun. Depending on the size of your refund, this could be anything from buying some new clothes you’ve had your eye on to taking an impromptu trip. Regardless, enjoy the fruits of your labor.