What To Do With Your Tax Refund (Smart Tax Refund Investments)

tax refund tips

If you get a tax refund, it typically means you overpaid your taxes the previous year.

The average tax refund in 2020 was $2,741.

You can request a tax refund by filing an annual tax return. Tax refunds are issued in the form of U.S. savings bonds, personal checks or direct deposits to your bank account.

When you get a sizeable tax refund, it can be tempting to splurge on a luxurious vacation or make a big-ticket purchase.

A tax refund offers you a great opportunity to improve your current financial situation. If one is coming your way, here are a few ways to use it wisely:

Pay down existing debt. Plan to clear off any high-interest debts. This includes your credit card debt. Delay in paying the debt can accumulate to an overwhelming debt that might cripple your finances in the future.

You should also consider clearing other debts even if you do not have credit card debt. Pay your student loans, bills, mortgages, and other outstanding debts.

Not only will you have peace of mind knowing that you do not owe anyone, but paying debts also has a positive impact on your credit score.

Tip: Check the loan terms on all existing debts to avoid paying a high prepayment penalty.

Set up an emergency fund. Do you have an emergency fund? How do you plan to take care of financial emergencies in the future?

Consider putting aside some money for a rainy day. This will prevent you from borrowing money when unexpected expenses occur.

Ideally, aim to have enough in your emergency fund to cover 3-6 months of must-pay living expenses. It may sound like a small thing, but it can save you from having to take more debt on a high-interest credit card.

To know how much you should set up in your emergency fund, analyze your needs first.

Open a savings account for future plans. Perhaps you plan to go on a vacation within the next few months. You may be having a wedding in a few years or months. These are significant expenses that can throw your finances off balance if you do not plan earlier.

Use your tax refunds to set the ground for your savings. The best way to keep your savings consistent is by setting an automatic transfer – from your checking account, for example — to the account to help you avoid accessing the money when not necessary.

It’s easier to manage your emergency money if you keep it from your regular accounts.

Establish an Individual Retirement Account (IRA). Another way to invest your tax refund is by opening an individual retirement account. If you already have one, you can increase your contributions to your 403(k) or 401(k).

Experts advise to save more in the retirement account to enjoy a comfortable retirement. This is a long-term investment plan. You can start gradually and increase your contributions based on what you’re willing to save.

Invest in stocks. Investing in stocks can help you avoid spending your tax refund on non-tangible things. If you are financially stable with an emergency fund, consider investing your tax refund in the stock market. You can open a brokerage account to invest.

Remember, the stock market is not a walk in the park, so before you invest, do intensive research in the field and choose the best option. You can also consult a financial expert with an adequate understanding of the stock market to avoid risking your finances.

Increase your liability coverage. You may want to ensure that you are safe from life situations by increasing your liability coverage. For instance, if you live in a flood-prone area, you can take flood insurance to cover future occurrences.

You can also increase your car coverage. Such decisions play a crucial role in mitigating future risks, and the painful what-if questions will be a thing of the past since you will have adequate coverage.

Remodel your home. If you are a homeowner, you can spend some of your tax refunds to remodel your home. You can repaint, upgrade home appliances, improve your curb appeal, and change your furniture, among other home improvements.

This is a significant investment that will add value to your home, especially when you decide to sell it. No buyer wants to spend money on a home that needs many repairs.

Even if you do not plan to sell your home, these improvements can make you comfortable, giving you peace of mind and feeling relaxed.

Invest in yourself. You can invest your tax refund in activities that improve your quality of life quality. For instance, you can advance your education, learn new skills relevant to your profession, or pay for membership in a professional organization to increase your earning potential.

Always think before you invest in yourself. Some things are not worth your time and resources. Invest in what makes your life better.

Donate to charity. Donating money to a cause you care about shows that you have good intentions towards the community.

Identify charity organizations that offer a significant impact on the community. Ask a few questions to determine how the nonprofit organization plans to spend your donations.

There are many charity organizations out there. Before you decide, make sure your donation, no matter how small, will make an impact.

The bottom line

It’s not about how much money you receive but how well you spend and invest. Your tax refund can be a great opportunity to put you on the path to financial independence.