It’s tax season, which means millions of Americans will be filing their taxes and receiving a refund in the coming months.
Getting that much money dropped into your bank account can be a bit of a shock, and it’s easy to spend the extra money without thinking about it. Here are some of the best things to do with your tax return.
1. Build an Emergency Fund
One of the first things you should do with any extra money you have is build up an emergency fund. An emergency fund can be the difference between being able to handle an unexpected expense and going into expensive credit card debt.
Your emergency fund should be large enough to handle any unexpected expenses that might arise.
A common rule of thumb:
Make sure the fund has 3-6 months’ worth of your expenses.
That means if you spend $2,000 each month, you should have at least $6,000 to $12,000 socked away.
Use an online savings account to store your emergency fund as they pay the best interest rates.
2. Pay Down Your Debt
If you’re in debt, especially if it’s high-interest debt, using your tax refund to make an extra payment on that debt is a great idea.
When you make an extra payment on your debts, you’re capturing guaranteed savings by reducing the interest that will be charged on the loan.
If you didn’t have any plans for your refund, using it to pay down debt helps you save money in the long run and escape debt more quickly.
3. Fund Your IRA
Though retirement might be a long way off, it’s never too early to start planning for it.
To help people save for retirement, the government has created the individual retirement account (IRA) which has a number of features that encourage people to use it save for retirement.
You may have the choice between a traditional or Roth IRA. Each one has its own tax advantages when you set aside money for the long term.
Using your tax refund to fund an IRA could help to reduce your tax bill next year.
If you're covered by a retirement plan, you can determine if your deduction amount is affected
|If your filing status is...||And your modified adjusted gross income (AGI) is...||Then you can take...|
|single or head of household||$63,000 or less||a full deduction up to the amount of your contribution limit|
|more than $63,000 but less than $73,000||a partial deduction|
|$73,000 or more||no deduction|
|married filing jointly or qualifying widow(er)||$101,000 or less||a full deduction up to the amount of your contribution limit|
|more than $101,000 but less than $121,000||a partial deduction|
|$121,000 or more||no deduction|
|married filing separately||less than $10,000||a partial deduction|
|$10,000 or more||no deduction|
If you’ve already built an emergency fund and funded your IRA for the year, you can still invest your tax refund.
You can use it to buy individual stocks or bonds, but a more balanced approach would be low-cost index funds.
5. Pay for Home Improvements
If you’re a homeowner, you know how expensive it is to maintain your home, let alone make some upgrades.
The influx of cash from your tax refund can be a good start for a home improvement project. If it’s large enough, you can use the refund to pay for the whole improvement, or as part of the down payment on the loan that you use for the project.
Home improvement projects, like building a deck, adding a room, or finishing a basement let you get more out of your space.
They also tend to improve the value of your home, so you can get a dual benefit by using your tax refund to pay for home improvements.
6. Replace an Old, Inefficient Appliance
If you live in an older home, or just have some old appliances in your home, you can use your tax refund to replace an old appliance.
Old appliances don’t have nearly as many features as more modern ones do. Upgrading your washing machine, oven, or other large appliance could make your chores easier or more fun to do.
Another major benefit of modern appliances is that they are far more efficient than old ones.
For example, buying a new refrigerator can save you hundreds or thousands of dollars a year, even after accounting for the purchase cost.
You get these savings through the reduced electricity use compared to your old appliance.
7. Invest in Yourself
Another option for your tax refund is to use it to invest in yourself.
Depending on your line of work, there are a lot of ways you can use the cash to improve your career prospects.
For example, people who work in information technology, there are all sorts of certifications available that will help you get a promotion or increase your income.
Even if your chosen career doesn’t have many certifications available, you can still use the money to pay for further education.
The more you learn, the more versatile an employee you can be, increasing your value to prospective employers.
Spending some money on your education can help you earn a promotion or change careers to something that is more lucrative.
8. Save for an Upcoming Expense
One common mistake that many people make when they build their budget is failing to budget for large, but irregular expenses.
For example, if you need a car, you should be budgeting some money each month for an eventual replacement for your car. While we’d all like our cars to run forever without breaking down, the reality is that even if we don’t want to upgrade to a newer car, eventually cars break down for good.
Other large, but irregular expenses include yearly bills or subscription services like real estate tax or magazine subscriptions.
If you know of some large expenses coming up, you could put your tax refund into a savings account so you have some money ready for when those expenses show up.
9. Make a Charitable Donation
If you’re feeling altruistic, you can use your tax refund to make a charitable donation.
There are thousands of charities across the United States and the globe that do good work, and donations from regular people are essential in making sure those charities keep running.
You can donate some or all of your tax refund to a charity that supports a cause that’s important to you.
As a potential benefit, you may be able to deduct charitable contributions from your income at tax time, assuming you itemize deductions. (However, because the standard deduction is quite high, the tax benefit from charitable donations is not very attractive.)
If you do want to make a charitable donation, you can use an organization like Charity Watch to research potential charities.
10. Buy Something Fun
Using a tax refund to buy something fun is probably the most common thing to do.
It’s hard not to see an unexpected influx of cash without immediately thinking about the fun things you could buy.
While you would benefit the most in the long term from using your tax refund to invest, pay down debt, or do something else to better your finances, don’t discount the benefit of buying something fun.
Using your tax refund to go one a nice vacation or get a gadget you’ve had your eyes on for a while can help relieve some stress and might help you avoid the temptation of spending money on other things.
Try to save or invest some or most of your refund, but don’t be afraid to have a little fun as well.
Stop Worrying About Tax Refunds
Though getting a big tax refund might be fun, it’s actually not a good thing at all.
When you get a tax refund it means that you’ve made an interest-free loan to the United States government. Your tax refund is just the government’s way of paying you back.
Had you kept the money for yourself rather than lending it to the government, you could have used it to invest or pay down debts, bettering your finances.
Use the IRS Withholding Calculator
The best way to get your refund as close to $0 is to use the IRS Withholding Calculator.
You’ll be asked a series of questions that pertain to your tax situation, including your:
- Filing status
- Employment/job status
- Tax credit eligibility
- IRA contribution
Make sure to have a copy of your most recent paystub on hand. It has the information you’ll need to answer the calculator’s questions.
Once you’ve entered your information, the calculator will determine two things:
- How much tax you’ll owe for the year
- How much more you need to have withheld from your paychecks to hit that amount.
- What number to enter on each line of your W-4 at your jobs. Your W-4 is used by your employer to determine how much should be withheld from your paycheck for taxes.
If you answered the calculator’s questions accurately and followed the instructions it provides, the result will be that your refund at the end of the year will be as close to $0 as possible.
Quick Facts About Using the Withholding Calculator
|If you...||Then you should...|
|Have a new job||Fill out an IRS Form W–4 and give it to your employer - the deadline for putting your new form into effect is the start of the first payroll period ending 30 or more days after you turn it in.
*you may be able to avoid over-withholding if your employee agrees to using the part-year method.
|Have two jobs||Be sure to include information about both jobs when using the Withholding Calculator - you can claim all your allowances with one employer and none with the other, or divide them any other way you find best.
*you cannot claim the same allowances with more than one employer at the same time.
|Are married||Figure your withholding allowances using your combined income, adjustments, deductions, exemptions, and credits using the Withholding Calculator together.
*you can divide your total allowances any way, but you cannot claim an allowance that your spouse also claims.
|Are not getting the right amount of tax withheld||Take note of these things that may be causing the error:
While getting a tax refund is great, remember that it was your money
It would be wise to not treat it as "free money" and be sure to use it to improve your financial situation.
You've set the correct tax withholding amount so that you don't need a tax refund -- you're likely to find that you're getting "more" (as in, the correct amount) money from your paychecks.