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Tax Refund Burning a Hole in Your Pocket? Here Are Five Ways to Use It Wisely

Five Ways to Use Your Tax Refund Wisely:

Ideally, your tax refund shouldn’t be at a level that makes you want to do a touchdown dance. Large refunds mean the taxing authorities are getting an interest-free loan from you during the year. Sure, it’s nice to get a sum of cash to do something fun with. Wouldn’t it be better if you had use of that cash during the year by having less taxes withheld and a bigger paycheck? But … what would you do if you had bigger paychecks?

Maybe you have the discipline and systems in place to set the cash aside from each paycheck instead of spending it. However, many people don’t, no matter how much they make, so they look at it as a forced saving strategy. Hey, if that works best for you, great. Personal finance strategies are as much about what makes financial sense as they are about what actually works for you with your behavioral tendencies. It then becomes a question of what to do with that refund. It was a forced saving strategy for … what? Consider carving out a portion for something fun and use the rest for something that puts you in a better financial position. Here are some possibilities:

1. Beef up your Emergency Fund

    Generally, your emergency fund should be three to six months of living expenses, or higher if you have job insecurity, dependents, or are retired. These cash reserves can cover living expenses should you lose your job, face a health issue, or while you wait out a bad market decline in retirement. It can also cover unforeseen expenses that can easily arise such as car repairs, home repairs (i.e., furnace, water heater), medical emergencies, children-related expenses, etc.

    2. Knock Down Debt

    If you have credit card balances, use some of the refund money to knock down the balance and save yourself some interest and stress.

    3. Put it Towards Retirement

    Retirement can seem so far away (sometimes even if it’ll be next year), but saving as much as you can, as early as possible, can mean less out of your pocket later due to the power of compounding. Let the money do some of the work for you. If $100 earns a hypothetical average annual return of 8 percent, you’d then have $108 earning 8 percent, which then becomes $116.64 earning 8 percent, and so on. The more time you have for that magic to work, the greater your earnings might be and the less cash out-of-pocket you’d need to accumulate a retirement nest egg.

    4. Save for College

    If you’ve determined that you can afford to save for college without jeopardizing your retirement security, consider using some of your refund to add to your college savings accounts. A 529 college savings plan is an effective vehicle to use for this purpose. Review the options available in your home state as there may be tax advantages for using your state’s plan. For instance, New York allows a married couple an income tax deduction of up to $10,000 for contributing to the New York 529 plan and the funds can come out tax-free if used for qualified education expenses in the year incurred.

    5. Improve your Home

    If there are some home improvements you’ve been hoping to do, your refund could help keep you from having to borrow the money to do so. As with everything else, balance this wish-list item with your other goals to make sure everything is properly prioritized. We’ve seen clients over-extend themselves in this area, leaving something else at risk (i.e., retirement).

    Your refund might feel like found money, but rather than spending it all on something frivolous, now is your chance to do something practical with at least some of it that you might get longer-lasting results from.

    If you need further guidance or have any questions on this topic, we’re here to help. Please do not hesitate to reach out to our trusted experts to discuss your specific situation.

    This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.