6 Ways to Use Your Tax Refund Wisely

Receiving a large tax refund can be a great feeling. For many people, it's the biggest check they receive all year. In fact, about 3 in 4 Americans receive a tax refund each year, with the average federal tax refund being $3,200 in 2022. While it’s exciting to get a tax refund, it's important to remember that the money you got back was yours all along and that a refund is simply you getting the money back that you loaned Uncle Sam last year (interest-free, might I add). It can be tempting to spend the money on something fun, but it can also be a great opportunity to use the money to move your financial situation forward and get one step closer to reaching your goals! 

Here are some ideas on how you can use your tax refund: 

Pay off high-interest credit card debt 

If you have high-interest credit card debt, consider using your tax refund to pay it off. The average credit card interest rate is 19.28 percent, which can make it difficult to pay off quickly. You may have more than one credit card or other bills with high-interest rates, so consider paying off the bill with the highest interest rate first and the required minimum on the others. 

Add to your emergency fund 

Life is unpredictable, and unexpected emergencies can happen to anyone. The whole world experienced one in 2020, when COVID-19 caused great financial hardship for many people. In the autumn of 2021, some 63 million Americans (29 percent of the adult population) reported it was difficult to pay for household expenses such as food, rent/mortgage, car payments, medical expenses, and student loans. Consider using the money from this year’s tax return to build up your emergency fund. We recommend saving three to six months of expenses in a money market or savings account for that rainy day — or year. Even if your emergency savings are close to zero, any amount you start with will help.

Invest it

Allow your tax refund to work for you by investing it. Let’s take the average tax refund as an example, let’s say you invested the $3,200 in an index fund earning 8% on average. In 20 years, that $3,200 would have grown to $14,915. What if you invested the $3,200 every year for 20 years? You would have $173,068, even though you only invested $64,000 of your own money. Keep in mind, there are endless investment options out there depending on your time horizon and risk tolerance. If you are looking for something guaranteed but want to get some growth to try to keep up with inflation, consider a CD or a structured product like a market-linked CD. 

Add it to your retirement savings.

If you are comfortable investing for the long run, consider investing underneath a retirement umbrella. Retirement accounts give you tax advantages that you don’t get in a regular taxable investment account, for example, tax-deferred growth. Most employer-sponsored retirement plans, like a 401k, require contributions from your paycheck but individual retirement accounts (IRAs) allow you to make lump-sum contributions. In fact, you can still contribute to your IRA for 2022 up until April 18th of 2023. The maximum contribution for 2022 is $6,000 if you are under 50 and $7,000 if you are over 50. There are income limits to be aware of so make sure you consult with your advisor or CPA prior to making a contribution. In 2023, if you’re under the age of 50, you may contribute up to $6,500. If you’re older than 50, that amount can increase to $7,500. 

Start a business 

If you've been spending more time at home during the pandemic, you might have discovered or developed a talent, such as woodworking, painting, or baking with sourdough. And now you want to turn your hobby into a side business. Your tax return could serve as seed money to build up your inventory or develop a website for your new money-making gig.

Start a college savings account

The price of a higher education is expensive. Setting up a college funding account with your tax refund may ease the future financial burdens of an education. Many Americans use student loans to help pay for their education. To help offset the price, consider investing in a tax-advantaged vehicle, such as a 529 plan, well before your little one heads to the halls of academia. Tax benefits include tax-free earnings and withdrawals for qualified educational expenses. Also, a 529 plan will not negatively impact your child’s ability to qualify for federal aid.

In the end, a tax refund can be a great opportunity to invest in your financial future. Every dollar you save or invest is getting you one step closer to achieving your financial goals.

*The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual.