A windfall from your taxes gives you lots of options. While it may be tempting to splurge on something that makes you happy right now, the smart move is to use the money in a way that pays dividends in the future. Here are six things you can do to keep your tax refund working for you.
1. Save it for an emergency
The unexpected happens, and it often comes with a price tag attached. Rather than letting a financial setback bust your budget or plunge you into debt, put your tax refund into a savings account to use in a financial emergency. With savings on hand for a car repair, medical emergency, or sudden job loss, you can avoid costly short-term loans or high interest credit card charges. Your tax refund affords you an easy way to jump start a savings plan that will give you peace of mind once it’s in place.
2. Wipe out debt
Receiving a sizable tax refund might seem like the perfect opportunity to get into the stock market or open a money market account, but that might only be true if you are out of debt. That’s because the interest you pay on debt can eat away at any gains your money earns in investments.
For example, if you invest a $3,000 tax refund in a fund that yields 2% annual interest rate, you’ll earn $60 for the year.
- $3,000 x .02 = $60
But if you maintain a $3,000 balance on a credit card that charges an 18% interest rate, you’ll pay $540 in interest for the year, more than wiping out your financial gain.
- $3,000 x .18 = $540
By paying off your debt first, you can reduce your monthly expenses, allowing you to begin putting aside money to invest later.
3. Save for your retirement
Retirement may seem far away, but putting money into a Roth or traditional IRA can have short-term benefits as well. The contributions you make to a qualified retirement plan can be tax deductible, up to $6,000 if you are under age 50 (and up to $7,000 if you are age 50 or older). These contributions can reduce your taxable income and lower your taxes. Meanwhile, the money you invest can grow tax-free until retirement, leaving your older self better off financially—not to mention proud of the foresight you showed by saving for tomorrow rather than spending today.
4. Fund college for your children or grandchildren
It’s never too early to plan for paying for college for your children. Putting your tax refund into a 529 plan can allow the savings to grow tax-free. You won’t pay income tax on the withdrawals, either, as long as you use them to pay for qualified higher education expenses. Beginning in 2018, you can use 529 plans to pay for private or public elementary, middle, and high school tuition as well. Although you can’t deduct the money you put into a 529 on your federal taxes, some states do allow you to deduct the contributions from your state income taxes.
5. Put your money into the stock market
Want to see your tax refund grow? History suggests that the stock market might be a good place to invest it. Stocks have offered a better return on investment than bonds, certificates of deposit, or traditional savings accounts. Of course the market goes up and down, which can make it risky for short-term investments. But over the long term, the stock market has generally performed better than many other investments. To reduce risk compared to owning individual stocks, consider investing in an index fund, which combines multiple stocks into one portfolio that is designed to mimic the performance of a market index such as the Standard & Poor's 500 Index (S&P 500).
6. Upgrade your home
Putting your tax refund into home improvements can pay several dividends. Upgrading your windows can prevent the loss of cool air during summer and heat in the winter, reducing your energy costs. Replacing old appliances with new, energy efficient models can also cut your power bill and save you money. Updating your kitchen or bathroom might not only make for more comfortable living but can also boost the value of your home, should you decide to put it on the market.