What To Do With Your Tax Refund: WalletHub’s 12 Tips
Each year, more than 70% of taxpayers receive a refund from the IRS because the amount withheld from their paychecks throughout the year wound up exceeding their ultimate income-tax liability. We’re not talking chump change here, either: The average refund tends to be a little more than $3,000, according to IRS data.
That’s a lot of money for anyone, especially in the current economic climate wherein job security is tenuous, student-loan debt has surpassed $1.2 trillion, and the average household owes about $7,879 to credit-card companies, according to CardHub’s latest Credit Card Landscape Report.
But, as you’ll see below, there’s often a big disconnect between what we should do with our tax refunds and what actually ends up happening. “There is no need for you to be feeling taxed, though,” says Nicole Lapin, CNBC anchor and personal-finance author. “There are ways you can use your refund that are practical and will leave you feeling guiltless.”
That’s certainly true, and here are 12 of the best ways to put your tax refund to good use:
The 12 Best Ways To Use Your Tax Refund
Weave A Financial Safety Net: For many folks, the economic distress of the Great Recession was exacerbated by misplaced, or perhaps unhedged, optimism. We thought income levels could only go up, so there was no need to bother establishing financial reserves in an emergency fund. Of course, we then had nothing to live off of during the extended periods of unemployment that characterized the downturn for so many Americans.
As a result, your top financial priority these days should be to gradually put away about a year’s after-tax income in case another break-the-glass situation comes about. Believe it or not, establishing at least minimal financial reserves is more important than paying off existing balances given that even if you’re debt-free, you’re only one major unexpected expense away from being back in the red if you don’t have an emergency fund.
So while “this one is easy to say, harder to do,” according to Lapin, if you “put your refund aside for bills down the road, or a big project or emergency that might come up … the next time you reach for it, you’ll be surprised at how much you’ve got in the can.”
Get Debt Off Your Back: No one wants to live with the increased costs and stresses that accompany unnecessary debt. The most strategic way to pay off amounts owed is to attribute minimum payments to all but the balance with the highest interest rate, to which you’ll allocate the remainder of your allotted monthly debt-repayment amount. Once your most expensive debt is gone, repeat the process until you’re debt-free.
If you have good or excellent credit — find out with a free WalletHub account — the right balance-transfer credit card could be quite valuable to this exercise. For example, Slate from Chase, the best balance-transfer card that’s currently available, offers 0% financing on transferred debt for the first 15 months that your account is open and charges neither a balance-transfer fee nor an annual fee. You can consult a credit-card calculator to see exactly how much such an offer would save you, but it would likely amount to more than $1,000 for the average household.
Invest In Your Future Self: Whether it’s putting your money in an IRA to lower next year’s tax balance, adding to a 529 Savings Plan to help pay for your child’s education or further diversifying your stock portfolio, there are plenty of sound investments to be made these days.
And if you stash your cash somewhere safe and leave it there for years, you’ll see just how powerful compound interest truly is. For example, if you put the average American’s $3,120 tax refund into an ETF that tracks the S&P 500, historical averages indicate that it would grow to $6,138 after 10 years and $16,934 after 25 years.
Don’t ignore the benefit of investing in yourself through the likes of continuing education classes, either. If you know that the degree will increase your future earning power, then it should pay for itself in the long run, provided you approach the process strategically.
- Refinance Your Home Loan: Mortgage rates have risen of late but continue to hover near historic lows. And your tax refund might just allow you to afford the closing costs associated with a refinance, making it nothing but a money-saving proposition. Just make sure to do your homework before pulling the trigger.
Boost Your Property Value: Are you handy? If so, you could literally build home equity in preparation for a future sale or simply reduce some pesky household costs.
“Take a look around the house, the yard,” Lapin suggests. “Are there any big projects that you’ve been meaning to tackle? Often these maintenance projects are long-term money-savers, like a new storm door to save on heating costs in the winter or a high-efficiency dishwasher to preserve water. And if you plan to sell your home down the road, even better. Now is the time to invest your tax refund in these projects, and pocket some cash later.”
Start A Business: Perhaps you’ve been contemplating a career change, or maybe you just want an alternative revenue stream. Well, why not consider your IRS refund as seed money?
After all, it’s a very cheap alternative to most business funding options. And while a couple thousand dollars obviously won’t cover all of your expenses, it’s a start — maybe even to something big.
Go To The Doctor: Although more Americans have health insurance these days, it’s still not cheap. And costs aside, many of us still don’t like to visit the doctor. Roughly 17% of people have had no contact with a health care professional between 2013 and 2014, according to the National Center for Health Statistics.
But regular preventative care has shown to significantly reduce long-term health-care costs and save the economy billions of dollars in annual productivity, according to the Centers for Disease Control and Prevention. So now that your tax refund gives you little financial excuse to dip out of work for an hour in the name of wellness, do yourself a favor and get a checkup. After all, your wallet is only ever as strong as you are.
- Join A Fitness Club: A decent gym membership would account for only a fraction of the average person’s tax refund, but it could set you up for big-time savings. Not only does improved health reduce the cost of health insurance and medical care, but it will also make you more productive and thus boost your earning potential.
Avoid Prepaid Cards: This isn’t really a tip for how to use this year’s tax refund but rather procedural advice for how to receive it. Many tax preparers and some states offer to disburse tax refunds via prepaid card, which might at first seem convenient. But prepaid cards often charge a variety of small fees that can eat away at your money over time if you’re not careful. And though long-term prepaid card users can avoid many such fees with careful account selection, you aren’t given any choice when it comes to tax-refund cards.
That means direct deposit is the way to go whenever possible.
Pay Next Year’s Taxes Today: Now, it’s important to note that you should not actually fork over cash to Uncle Sam early, as doing so would represent the same sort of mistake of which a tax refund is emblematic. But you can essentially earmark the money to be used for next year’s tax obligations, further reducing the amount you must withhold throughout the rest of the year and ensuring that you will not face a deficiency.
For this strategy to work, you will need to keep your funds in a liquid account that allows you to access the money at will – including to make quarterly tax payments if you’re self-employed – with no penalty. So that rules out certificates of deposit (CDs) and volatile investments. One really good option might surprise you: an online-only checking account. But they actually offer the market’s highest average APY.
Treat Yourself: At the end of the day, it’s important to note that not every single dollar of your refund must go to practical concerns. “You can have a little bit of fun with those extra dollars!” Lapin says, and the sentiment is spot on. Financial discipline is very hard to maintain, and you can increase your odds of using the bulk of your refund responsibly by earmarking a small portion — 5%, perhaps — for fun from the very beginning. It’s motivation.
“You can buy yourself splurge-items that are usually out of reach — a tropical vacation, trendy shoes or the newest gadget — just be smart about it,” Lapin suggests. “There’s nothing wrong with treating yourself, but set a limit so that you’re still saving, and remember, it’s not ‘free money’ — it’s your money!”
- Give Back: For many people, financial donations to charity go a lot further than manual labor. If you’re in that boat — try our Charity Calculator to find out — and you’re philanthropically inclined, passing part of your refund along to those who perhaps need it more would be a noble move. It’s not the most strategic option for your own personal finances, though donations would be tax-deductible next year if you itemize – but it would serve the greater good.
Note: WalletHub would like to give special thanks to money expert Nicole Lapin for sharing her wonderful insights with our readers! Lapin hosts the business-competition show “Hatched” on The CW, and is an anchor for CNBC and CNN Live. She also created the AOL Originals show "I’ll Never Forget My First" and authored Rich Bitch: A 12-Step Plan for Getting Your Financial Life Together…Finally.
Image: Catherine Lane / iStock.
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