Three Ways to Make the Most of Your Tax Refund
Before you spend your tax refund, consider how it could help you achieve long-term financial goals.
It's that time of year. Many people are getting their income tax refunds and making plans for spending them. You may be tempted to go on a shopping spree, but before you blow through your refund, take some time to think about your priorities and long-term financial goals.
1. Pay off any debts.
As you receive and/or anticipate your tax refund, you should take the opportunity to review your finances and debts. Determine which ones you can eliminate and/or significantly reduce with some help from your incoming lump sum. This may not be the most exciting way to spend your money, but it's likely the smartest.
Reducing debt can provide you with greater financial freedom and help your credit score, making it easier to get financing and better rates for large purchases in the future. Knowing you no longer owe money can reduce stress and even help you live a happier, healthier life as a result. Now is the time to examine auto loans, student loan debt, credit card balances, and mortgages to see where your tax refund money can be put to best use.
AffordAnything.com founder and CEO Paula Pant recommends prioritizing your debt by interest rate.1 "This is known as the 'debt avalanche' method, and mathematically, it's the one that will save you the most money over the course of your debt repayment journey," she explains. "What you need to do is order your debts from highest interest rate to lowest interest rate. By focusing on paying off your debt with the highest interest rate first, you save more money, because the interest that's accruing on your accounts will decrease. Interest can be an extremely nasty factor in your debt repayment plan if you're not careful."
2. Create an emergency fund.
The next best thing you can do with your tax refund, beyond paying off debt, is simply saving the money. Set up a savings account if you don't already have one and put your money there, where it will accrue interest over time. You can save your money for a particular purchase down the road if you like, but a better idea is to use your savings as an emergency fund. You may even consider creating an account separate from your main savings specifically for this purpose.
“Prioritizing your tax refund to create an emergency fund and pay off debts first will help position you for financial comfort the rest of the year,” says Corey Carlisle, executive director of the ABA Foundation, the American Bankers Association's community engagement foundation.2 “As those who have been affected by the federal government shutdown this year can attest, financial challenges can arise quickly and it's critical to have money set aside for those unexpected hardships.”
Have you ever considered how you would get by in the event that life throws you a major curveball? What if you become unemployed or you or a family member becomes sick and you're left with a mountain of medical bills? Having an emergency fund means having financial security when you need it most. Receiving your tax refund may be the best chance you have during the year to add significantly to this fund.
3. Pad your retirement account.
Receiving a tax refund can be a good time to add to your retirement account, whether you have an IRA or a simple savings account that you're not tapping into until you retire. You may need the money once you're no longer working, so why not add as much as you can while you have it to add? Your future self will thank you.
If you use a 401(k) in which your employer matches contributions and your refund is large enough, you may consider increasing the amount that enters your 401(k) from your paycheck to take advantage of your employer's contributions even more. The money from your refund may be able to help make up the difference for day-to-day expenses.
The information provided is presented for general informational purposes only and does not constitute tax, legal or business advice. Any views expressed in this article may not necessarily be those of Nevada State Bank, a division of Zions Bancorporation, N.A. Member FDIC