Why Do You Need an Emergency Fund?
- Job loss or unemployment
- Medical or dental bills
- Home repairs
Even if you’ve got your budget nailed down and you’re saving money regularly, it never hurts to have a little something extra come your way. As tax season goes into full swing, you may be excited about the possibility of receiving a sizable tax refund. In 2017, for example, the average refund totaled $2,895, according to the IRS.
Even though tax season happens predictably every year, have you ever found yourself wondering, ‘What do I do with my tax refund?’ If so, and if you’re expecting a refund this year, now’s the time to consider where it fits into your financial plan. Preparing in advance for ways to spend your tax refund lessens the odds of being caught off guard when it lands in your bank account. Putting in the prep time now may also help you avoid splurging on an impulse buy.
Here are a few ways to use your tax refund wisely:
There are many possible things to do with your tax refund, especially if you have multiple financial goals. Mario Costanz, CEO of Happy Tax, a tax preparation service in Miami, says to ask yourself which of your goals would benefit the most from an unexpected cash infusion.
Sometimes it’s a tough call, he adds, since financial priorities often compete. You may be torn between saving for a child’s college tuition or putting away money for retirement. Paying off debt may also be on the list of ways to spend your tax refund.
Applying a refund to debt may seem logical if you’re paying high interest on credit cards or loans. But, it might not be one of the best ways to use your tax refund wisely if you have no savings at all. Sam Price, an independent insurance broker and owner of Assurance Financial Solutions in Birmingham, Alabama, says starting an emergency fund with your refund makes more sense.
“Emergencies are going to happen,” Price says, “and when they do, having three to six months of savings will stop you from having to charge more debt on a credit card that you’ll have to pay back with high interest rates.”
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Socking away that amount of monthly expenses in an emergency fund as a way to use your tax refund wisely, he adds, could allow you to cover minor bumps, such as a car repair, as well as major ones like job loss or an extended illness that keeps you out of work. According to a 2017 GOBankingRates survey, 57 percent of Americans have less than $1,000 in savings to handle these types of situations.
A savings account is often the most convenient place to park your emergency funds. With the Discover Online Savings Account, for instance, you can arrange to have your tax refund deposited directly into your account by providing Discover’s routing and your account numbers when you complete your tax return. The account offers a high interest rate to help you grow your savings faster—with no monthly fee for maintenance—and you can access your savings easily if an emergency occurs.1
In 2017 the average refund totaled $2,895.
In addition to saving for emergencies, paying down debt and funding other financial goals are productive things to do with your tax refund. If you have multiple debts, consider applying your refund to those with the highest interest first.
“Paying down $500 of a $3,000 credit card bill charging you 17 percent interest will save you more than paying off an extra $500 on your car loan,” Costanz says, “which may be charging you 5 percent.”
Paying down credit card debt ahead of other loans as a way to spend your tax refund could also improve your credit score. Credit cards are revolving debt, meaning you can use more—or less—of your credit limit as you make purchases and pay them off. One of the factors that affects your credit score is your credit utilization ratio, or how much of your available credit you’re using on revolving accounts. Costanz says using your refund to pay down cards that are near the limit could help improve your credit utilization ratio and boost your credit score.
If you’re looking for things to do with your tax refund and are behind on saving for retirement, you could split your refund between debt repayment and an individual retirement account (IRA). Price says if saving for a home is also one of your goals, a Roth IRA could be a good fit. These accounts allow you to save for retirement, but qualified first-time homebuyers can withdraw up to $10,000 without penalty to use for a down payment or other homebuying expenses, such as closing costs. Funding a Roth IRA as a way to use your tax refund wisely could help you work toward the dual goals of retirement and homeownership simultaneously.
When considering things to do with your tax refund, you can look past saving and debt repayment to find other ways to use your tax refund wisely. Spending money on yourself is important if it helps to better your overall well-being.
“Investing in yourself may be one of the best ways to use your tax refund. By committing energy and financial resources to your own personal development, you can learn new skills, pursue new interests or even build your career.”
Using part of the money to pay for a year’s gym membership, enroll in yoga classes or hire a personal trainer, for instance, are good ways to spend your tax refund if one of your New Year’s resolutions is improving your health. If you struggle with back issues or poor sleep habits, a new mattress could also be a good investment.
Enhancing your professional skills to increase your earning potential is another thing to do with your tax refund. If you work in a field that relies heavily on technology, you might consider enrolling in a remote coding boot camp. You could also use a refund to launch a side hustle or turn the business idea you’ve been kicking around into reality.
“Investing in yourself may be one of the best ways to use your tax refund,” Costanz says. “By committing energy and financial resources to your own personal development, you can learn new skills, pursue new interests or even build your career.”
Even if you plan to spend part of your tax refund, consider parking the extra cash in your savings account in the meantime. That way, you can be earning interest until you’re ready to make your purchase.
There are so many ways to spend your tax refund, and while it’s tempting to go on a shopping spree, that virtually guarantees your windfall won’t last. Consider your options for saving, paying down debt and spending the money on things or experiences that could yield a physical, emotional or professional benefit. Then make a plan and commit so that when your refund arrives, you’ll know exactly how to put it to work.
1Federal law limits the number of certain types of withdrawals and transfers from an Online Savings Account to a combined total of six per calendar month per account. There is no limit on the number of withdrawals by Official Check mailed to you. If you exceed these transaction limitations during any calendar month we may assess a per item Excessive Withdrawal Fee or refuse to pay each transaction in excess of the limitations. If you exceed these limits on more than an occasional basis, we reserve the right to close your account.
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1 Study by T. Rowe Price Retirement Plan Services.