Tax time is here, and many of you have already filed your taxes. If you haven’t, you have until April 18th to do so. Depending on your withholding, many of you will be getting a tax refund on the amount that you overpaid. This is an exciting time for many people as they look forward to receiving a sizable refund every year. You may like to use this money to upgrade your wardrobe, pay down student loans or credit cards, or use it to cross an item off of your bucket list. In this post, you will find a handful of good ideas on what do with your tax refund this year.
Build Up an Emergency Fund
Look, I know that this isn’t the “sexy” option. That being said, it is extremely necessary. More than half of Americans have less than one month worth of income readily accessible. If this sounds like you, you need to build up your cash savings. It is important to put this in an account that you aren’t tempted to use on everyday purchases, but to leave it aside for use in an emergency. I would suggest making a goal of having at least 3 months of expenses in this account. You can later graduate to having 6 months or more saved in your emergency fund. This way, a temporary health emergency or unexpected cost won’t cause you to make a decision that can negatively impact your long-term goals.
Pay Down Credit Card Debt
The next thing I would look at is paying down any high-interest debt. I’d start with credit cards. The average U.S. household is carrying over $15,000 in credit card debt. This is the worst kind of debt. Other debts, like student loans or mortgages, allow you to deduct the interest you paid on your taxes… credit cards don’t. The average interest rate on credit cards is over 16%. If you let your credit card balance get out of control it can become quite daunting to pay it off. Using your tax refund to pay this down (rather than getting a new shiny TV) isn’t the most exciting way to use your refund but may help you to get that monkey off of your back sooner.
Pay Down Student Loans
The average U.S. household that has student loans is currently carrying close to $50,000 of student loan debt! Now, I would pay off the credit card before focusing on paying extra towards student loans but if you don’t have credit card debt, student loan repayment is a great use of your tax refund. New undergrad loans have an average interest rate of 4.29%. Paying these off may free up more cash flow for you to invest toward retirement or to give you more discretionary income.
Start a Roth IRA
The largest component of most people’s retirement income is coming from their work retirement plan. The problem is, if 100% of your retirement savings are in a 401(k) or 403(b), your distributions will be taxed at your ordinary income rate and are also subject to required minimum distributions (or “RMD’s” at age 70 ½, whether you need the money or not). Having more flexibility regarding where you take your distributions from during retirement can be favorable; which makes a Roth IRA a great option. This is funded with after-tax contributions (your tax refund for example) and the growth of the account will be 100% tax-free for qualified distributions. Are you a young investor? Imagine you get, on average, a $3,500 tax refund. If you invested a $2,000 a year into a Roth IRA that averages a 7% return over 20 years, after those 20 years you would have $81,990! You contributed $40,000 and you now have $81,990 that is 100% tax-free and does not have any RMD’s.
Get a Financial Plan in Place
One wise way to use a tax refund is to finally get the help you need to reach your financial goals. Hire a financial advisor that will help you put your goals into perspective, use unbiased strategies to help you pursue those goals, and meet with you regularly to monitor progress and update your plan. (Integrity Wealth Advisors’ planning process)
Treat Yo Self!
Already have emergency savings, paid down consumer debts, are comfortable with the amount you are contributing to retirement plans, and have a financial plan? Well you my friend deserve a pat on the back.
You are a disciplined investor who has made some very smart decisions in regards to your pursuit of financial independence. For you, I would suggest three words from one of my favorite TV characters Tom Haverford and those are, “TREAT YO SELF!”