Once you receive a tax refund, there are a million ways to spend it. If you’re looking for a pick-me-up, you might be tempted to go on a shopping spree or a vacation.
However, using your refund to improve your financial life is definitely a prudent way to go. That might not be as fun as other options, but it’ll go a long way toward shoring up your financial security.
If you look forward to getting a tax refund every year, remember it’s not a gift from Uncle Sam. You probably worked hard to earn that money last year, or you qualified for some big tax deductions, or both. So, before spending it on something frivolous, consider these six smart ways to use your tax refund.
1. Build your emergency savings.
If you have little or no emergency savings, use your tax refund to build one. Make a goal to accumulate a minimum of three to six months’ worth of living expenses in an FDIC-insured bank savings account.
Having a healthy emergency fund gives you peace of mind and financial protection for the unexpected, such as a broken-down car, a high medical bill or losing your job. It’s one of the most important financial defenses you have, so it should be a top priority for your tax refund.
2. Manage risks.
Once you’ve established a cash cushion in your emergency fund, use your tax refund to fill any gaps in your insurance. Having enough of the right kinds of insurance is another important part of being prepared for the unexpected. Here are a few key policies to consider:
• Health insurance is a critical protection against an expensive doctor or hospital bill. If you or your dependents don’t have a health plan, use a tax refund to pay premiums for an affordable policy, such as a high-deductible plan.
• Disability insurance provides replacement income if you’re unable to work due to a covered disability, illness or accident. Remember health insurance only applies to your medical bills — it doesn’t pay your living expenses, such as housing or food, if you can’t earn an income for an extended period.
• Life insurance is critical when your death would create a financial hardship for those you leave behind, such as a child, partner or spouse.
3. Pay off expensive debts.
Once you’ve established financial security with an emergency fund and insurance, put your tax refund toward high-interest debts, such as credit cards, retail store cards, and payday loans.
Even if you can’t pay off all your expensive debts, reducing your balances cuts the amount of interest you must pay. Plus, whittling them down improves your credit utilization ratio, which helps increase your credit scores.
4. Contribute to a retirement plan.
If you participate in a retirement plan at work, such as a 401(k) or 403(b), put your tax refund in the bank and boost your contributions to the account. For 2019, you can contribute up to $19,000, or $25,000 if you’re over age 50.
You could also contribute to an Individual Retirement Account, which you open and fund on your own. You can contribute up to $6,000, or $7,000 if you’re over age 50. Contributions to a traditional account give you an upfront tax break because they’re excluded from your taxable income. You pay income tax on future withdrawals of contributions and earnings. For Roth accounts, there isn’t an immediate tax benefit, but your distributions are generally tax-free in retirement.
If you have a workplace plan, some or all your contributions to a traditional IRA may not be tax deductible, depending on your income and tax filing status. Also, be aware there may be tax penalties for withdrawing money from certain retirement accounts before you reach age 59½.
5. Fund a college savings account.
If you want to save for your education or a child’s, consider putting your tax refund in a 529 college savings plan. Funds in these accounts grow completely tax-free if you spend them on qualified education expenses.
6. Save for a special occasion.
If you have short-term savings goals, such as taking a vacation or buying a car, you could use all or a portion your tax refund to achieve them. Put your extra money in a safe place, such as a bank savings account that’s separate from your checking, so you won’t be tempted to spend it.