Spend a Tax Refund Wisely

If you're expecting a nice tax refund this year, you may be wondering how you should spend it. It may be tempting to go on a shopping spree, but there are lots of ways you can put that money to excellent use. No matter how much money you have and what your financial goals are, you can use your tax refund to help improve your future.

Steps

Saving for the Future

1. Save for emergencies. Even if you don't feel like stashing your money away for the distant future, you may want to consider starting an emergency fund to help pay for unexpected expenses that can pop up at any time. Try to put a little aside so you won't have to panic if you need an x-ray or your car breaks down.
   • Ideally, you should have enough money in your emergency savings account to cover six months worth of expenses. In addition to helping you with unexpected expenses, this account can be a life saver if you end up losing your job and need cash to pay your everyday living expenses.
2. Invest in your retirement account. Most people are not saving enough for retirement, so if you fall into this group, consider giving your 401k a boost. The more money you contribute to your retirement savings account when you are young, the more it will grow.
   • If your employer matches your 401k contributions, it's especially worthwhile to make extra contributions because you're passing up free money if you don't.
   • If you don't have a 401k at work, consider opening up a Roth IRA or traditional IRA.
3. Diversify your investments. If you are already saving for retirement and emergencies, consider opening a brokerage account to invest your extra money. If you invest well, your small tax refund could turn into a big nest egg.
   • Depending on your preferences, you could choose to work with a broker or open your account with an online brokerage firm that allows you to do trading yourself.
   • While you should make smart investments, you could use this money to buy stocks that are slightly riskier than you would choose for your retirement account. They could end up paying off big!

Making Smart Investments

1. Invest in home improvement. Investing in your home is a great idea because you will get to enjoy the improvements while you live there, and you can feel confident that your investment will pay off when you eventually sell your home. If possible, invest in improvements that are likely to appeal to a wide array of buyers for years to come.
   • Energy efficient appliances, windows, and insulation will all help you save money in the long run, so they will be worth the investment.
   • If you can't afford the home improvement project that you really want (or need) consider stashing your tax refund in a separate account and adding more to it each month until you can afford it.
2. Invest in a business. Whether you've always dreamed of opening your own business or you already have a business that could use a little extra boost, investing your tax refund in it is a wonderful way to help make your dreams come true and offer your family more economic stability.
   • If you haven't started a business yet, consider starting it on the side while you continue working at your regular job. If possible, keep costs low at first.
   • If you already have a business, try to think of a way that you could attract new customers. You might want to invest in a marketing campaign or a store renovation, for example.
3. Go Back to School or take classes. Few things are as stimulating and practical as your education. Just because you've been out of school for years doesn't mean you have to disregard the itch to learn. There are plenty of options for people who want to keep learning while working.
   • Get a certification in an area that is relevant to your job. It may help you earn that promotion you've been wanting.
   • Take night classes at your local community college or university. Whether you're working towards a degree or not, you will gain valuable knowledge.
   • Learn a language. Whether you choose to use computer software or a tutor who speaks natively, learning a language is a great way to keep your mind sharp while learning a bit more about a different culture.
4. Take a second look at your mortgage. If you have a mortgage on your home, you may want to consider using your tax refund to refinance it or to make an extra payment on it. Both of these options can significantly reduce the interest that you pay on your mortgage over time.
   • Check whether your mortgage has any pre-payment penalties associated with it. Prepay fees typically range from $200 to $500, but borrowers can generally pay up to 20% of their loan balance each year before the prepay fee kicks in.
   • If you have a large balance on your mortgage, only make additional payments if you have already paid off your other debt and have sufficient savings.
   • If you do decide to prepay, make sure you stress to your lender that you want your payment to go towards your principal. If you do not specify this, the lender may not apply the amount paid towards your principal.
   • If you're thinking about refinancing, check current rates to make sure they are significantly lower than your current rate. Remember that you will have to pay closing costs to refinance, but you may be able to reduce your monthly payments considerably.
5. Make a tax-deductible donation. If you don't need the extra money for yourself, considering donating it to help someone who does. The advantages of donating to charity are threefold: you can make the world a better place, you can make yourself happy by doing something good, and you can write off the charitable donation on next year's taxes.
   • Be sure to hold on to the receipt from the charity so you will have evidence of your donation when it's time to do your taxes next year.

Improving Your Family's Well-Being

1. Pay off your debt. Whether you have credit card debt, a car loan, or student loans, consider using your tax refund to pay them off (or at least make a dent in them). Not only will you feel much better without all this debt, but you will also have extra income each month once it's paid off.
   • If you have several sources of debt, pay off the debt with the highest interest rate first. This is the loan that you are paying the most interest on, so it makes sense to eliminate it first. Then pay off the debt with the second-highest interest rate, and so on, until all your debt is paid off. This is known as the avalanche method.
   • Another method, known as snowballing, takes the opposite approach. You pay off the smallest debt, thereby immediately eliminating one payment from your list of debts (paying of your largest debt or the debt with the highest interest payment may take some time, while paying off your smallest debt can potentially be done in a single payment). This has the added benefit of improving your morale and motivation — these "quick wins" will make paying off all your debt seem more doable.
2. Invest in your children's education. If you have children, the thought of having to pay for college one day is probably terrifying. That's why it's a good idea to start college savings accounts for them when they're young. If you contribute a small amount each year, it can really add up.
   • If you contribute to a 529 account, you may be able to deduct the contribution from your state income taxes (depending on where you live). With this kind of account, you can withdraw the money tax-free as long as it is used for educational purposes.
3. Take care of essentials. If you've been putting off buying something that you genuinely need because you couldn't afford it, there may be no better use for this money. Depending on your needs, this may mean getting your car repaired, replacing your broken washing machine, or getting your kids some new clothes.
   • Keep in mind that putting off necessary expenses can often end up costing you more in the long run. Take care of them as soon as possible to avoid ending up in an emergency situation.
4. Get insured. Insurance can be expensive, but it provides essential security if something bad happens in the future. If your family isn't sufficiently insured, consider using your tax refund to invest in some much needed peace of mind.
   • If you don't already have health insurance, you should seriously consider investing in a policy. If you do not have one available to you through work, you can purchase an individual or family policy through the federal health insurance marketplace or through your state's marketplace.
   • Get life insurance if you have a spouse or children who depend on your salary.You can get two types of life insurance: whole life and term insurance. Rates vary depending on your age, health, and other factors, but you may be able to get a good amount of coverage for just a few hundred dollars a year.
   • You may also want to consider increasing your homeowner's insurance to protect you from potential damages or purchasing an umbrella policy to protect you from liability if someone is injured on your property.
5. Invest in a Health Savings Account (HSA). Health insurance doesn't cover all medical expenses. A HSA is a savings account that you can use to set aside tax-free money for a wide variety of medical expenses, including deductibles and co-payments. Many employers offer these accounts, and you may be able to open one at a bank if your employer doesn't.
   • There is a cap on how much you can deposit into an HSA each year, but you can choose to keep contributing money and saving it for medical expenses that occur later in life rather than paying for every current medical expense with it.

Tips

• If you've been financially responsible all year and you're in good shape with your savings, there's nothing wrong with spending your refund on a nice trip or that new computer you've been wanting. Making yourself happy is a good investment too!
• If you got a large income tax refund, review your withholding and/or estimated tax payments to ensure you do not continue to give the IRS an interest-free loan every year. Maybe your tax situation changed last year and the refund was a fluke, but if you look forward to a big tax refund every year as if it were a savings plan or a windfall, think about making some adjustments so you can hold on to more of your money as it comes in.

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