Tax time is a stressful time of year. Everyday, new tax documents fill your mailbox or inbox and you’re forced to interact with financial professionals who will dig into your life looking for the best way to help you.
Getting a tax refund is often viewed as a win, but in all honesty… it’s a loss. You’ve given Uncle Sam an interest free loan and you’ve missed out on money every month that could’ve helped you win financially all year.
But, alas… if you’re getting a tax refund, you need to plan on how to utilize it effectively. Don’t compound on your year-long missed opportunities by blowing your tax refund on poor choices.
Let’s look at how you can best utilize your tax refund to increase your wealth!
Pay Off Debt With Your Tax Refund
Debt. Is. The. Worst… If you’re getting a tax refund this year, priority numero uno should be sending all of it to pay down your consumer debt.
Taking a big chunk out of your consumer debt will help you achieve both financial and debt freedom faster than you originally expected.
If you’re unsure which debt to attack with your tax refund, look at your balances and interest rates.
If you’re holding on to a high balance, high interest account… attack that! Paying off a large sum of this balance could potentially save you thousands of dollars in the long run.
Sure, it’s sorta boring… Ok, it’s super boring. I would love to spend my tax refund on pizza, beer, and a bad ass mini bike, but that wouldn’t exactly help me achieve the financial independence I so desire…
Some financial decisions are just that… boring. But they’re also smart and you’ll appreciate it in a few short years!
Fund Your Emergency Fund
If you lost your job and ability to work today, how long could you survive? A few weeks? A month? 6 months?
The money you need to have saved for a rainy day is called an emergency fund. It’s just that, cash set aside for an emergency.
That emergency can be a job loss, illness, inability to work, major home repair, major anything repair, or any other emergency.
This money sits idle like a financial ninja. You know the ninja is there…protecting you. You pray you never need that protection, but sleep well at night knowing it exists.
Your emergency fund is incredibly important. Having the ability to take on any storm and not fear losing your home or livelihood is important.
Taking your tax refund and dropping it into a general savings account to protect you from a rainy day might sound boring, but it’s actually a super cool move… and I’m proud of you for doing it. (high five)
Fund Your Retirement Account
If all goes to plan, you’re going to get old. When you get old, you won’t want to work, and you’ll need money to live on.
If you’re under 30, retiring sounds like its light years away but it’s not. Its coming and the decision you make now will directly impact your ability to kick it at the beach with the Mrs.
Taking your tax refund and investing it into a ROTH IRA is an incredibly intelligent decision. That money will grow over the next 20 to 30 years to a mind blowing amount.
Don’t believe me?
If you would invest $3,000 into the S&P 500 at the age of 30 and never contribute another dime… it would become $61,241.90 by the time you’re 65. This is assuming the S&P 500 continues to average a 9% return annually.
If that doesn’t sound cool enough, it gets better! That money won’t be taxed while its growing or when it’s distributed! (fist bump)
Before you blow that money now, consider what you could do with that money when you’re much older and much less willing to go to work every day…
Open A Brokerage Account
Maybe you’re one of the few folks who has a fully funded retirement account. Good for you, seriously… I’m proud.
If this is the case, maybe a post-tax brokerage account is a good place for that money to grow with the same compounding interest rocket fuel we just talked about?
There are many low fee index funds that would be a welcoming home for your tax refund.
Some great examples would be:
- Schwab S&P 500 Index (SWPPX): The expense ratio is 0.02%, or $2, for every $10,000 invested.
- Fidelity 500 Index (FXAIX): The expense ratio is 0.02%, or $2, for every $10,000 invested.
- Vanguard Growth Index (VIGRX): The expense ratio is 0.17%, or $17, for every $10,000 invested
- Vanguard High Dividend Yield Index (VHDYX): The expense ratio is 0.15%, or $15, for every $10,000 invested.
- Scwhab Small Cap Index (SWSSX): The expense ratio is 0.04%, or $4, for every $10,000 invested
- Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX): The expense ratio is 0.04% (my personal investment of choice)
If you’re debt free, have an emergency fund set-up, and feel like you’re in a good place with your retirement savings…a brokerage account might be an amazing idea.
After all, few ever become rich by going to work for someone else every day. Invest in your own financial future!
College Savings Account
Kids… am I right? Well, if you’ve got em… you should be planning for how to pay for their college education. Student loan debt is the cancer of the current generation.
Unfortunately, it doesn’t appear to be going away any time soon. College tuition rates are ballooning like my weight in the winter… ok, I haven’t gained that much weight.
Consider investing your tax refund into an Education Savings Accounts (ESA) or a 529.
ESA (Education Savings Account)
An ESA is a popular way to save for college utilizing your after-tax dollars. Your contributions aren’t tax exempt… but the growth will be entirely tax deferred and no taxes will be paid on the distributions if used to pay for educational costs!
There are some limits with an ESA. For starters, only individuals with a modified, adjusted gross income (MAGI) less than $110,000 a year, or couples (filing jointly) making less than $220,000, are eligible to utilize an ESA.
The contribution limit for an ESA is $2,000/year. That may not sound like a lot, but consider if you started saving $2,000/year when your child was born.
18 years later and at an average annual return of 9%, your balance would be just north of $82,000. That sounds great, but it gets better! You’ve only contributed $36,000.
That means $46,000 could be sitting there FREE FROM TAXES! One thing to consider is that once your child turns 18, the account is transferred over to them.
They will have control over the money and they can do what they please. This would include taking it out for beer money and paying taxes and penalties…
529 College Savings Plan
A 529 College Savings Plan is another popular way to save for college. You’ll also use your post tax dollars to save, the money will grow tax deferred, and the investment will not be taxed if used to pay for higher education costs.
A 529 College Savings Plan is FAR more flexible than an ESA. These plans are for all families, regardless of income level, and don’t carry a contribution limit. Stash that cash, baby!
The money in this account will be locked in to pay for college, or other secondary education expenses. If used for something else, it will accrue some tax issues and also a 10% penalty…
Another massive perk to the 529 College Savings Plan is the fact that you remain in control of the money once your child turns 18.
I’m not saying your kid will make poor financial decisions, but if my parents dropped $80,000+ in my lap at 18… I might have made some poor decisions.
Ok… I would have made some terrible decisions because I WAS JUST A BABY!
The way and amount you save is again, personal. If you’re starting later and want to really stuff an account with some cash, than a 529 might be right. If you’ve got 18 years to save, than the ESA could do the trick.
Either way, saving money to pay for your child’s college will set them up for some pretty incredible financial success. You’re a hell of a parent.
Create A Sinking Fund Account
Sinking fund? What the hell is that? A sinking fund is a savings account you create with a specific goal in mind. One very popular sinking fund is saving for the holidays or birthdays.
Personally, I know how stressful the holidays can be. Gifts are only getting more expensive and your income doesn’t magically increase after the month of October.
With that being said, you can set your tax refund aside to fully fund your holiday and birthday gifts for the entire year!
Imagine… you don’t have to think about how you’re going to buy gifts this year. The money is there, waiting for the perfect gift.
Did the clouds just part at your place too? Seriously… the sun hasn’t shined in Ohio in like 3 months and it just came out (looks out window). Wow.
Plan A Vacation
Everyone deserves some time away. Although my wife and I are incredibly frugal, we even enjoy a few days away from the farm to relax.
The issue is, we hate spending the money to make it happen! A tax refund could be a great opportunity to take a small trip and not accrue any debt while doing so!
Listen, I know it’s not the most “financially responsible” thing to do, but if you’re financial lives are in order and you haven’t treated yourself in a while… consider a long weekend away with your partner.
The key to this is not accruing or spending any additional money to fund the trip. Make your arrangements knowing you only have your tax refund to spend!
Dipping into your savings, or accruing debt is a no go! Enjoy the trip!
There are millions of causes out there who need your money to continue to fight the good fight. I’m not going to give any examples because donation is a very personal matter.
We each have our “thing” and unless your thing is hurting people or some kind of deviant behaviors, I’m sure there is a charity that could make good use of your tax refund.
Even though donating is a solid act of good human nature, it can also benefit you as well. The IRS allows you to claim donations as a tax deduction for up to 50% of your adjusted gross income!
Before you donate your money to a charity, do some due diligence and research the organization. If you’re 100% sure your money will go to the intended use… Donate away!
I personally loathe spending money on home repairs. Spending money on new toilets, sinks, carpet, hand railings, curtains… blah.
Alas… we must maintain this home we pay so much for. Spending your tax refund on some much needed home repairs might take the sting away from replacing that porcelain throne.
Home repairs can be expensive. A few common repairs could easily be completed for under $3,000.
Common home repair average cost:
- New hot water heater: $500 – $900
- Replacement windows: $400 – $500 each
- New sink: $250
- Refinish your kitchen cabinets: $2,500
- New bathtub: $2,800
- Replacement countertops: $2,800
- New garage door installation: $1,100
Not the most exciting use for your tax refund, but a true adult decision. Home maintenance prevents the need to dip into your emergency fund down the road. Repair that roof, replace those sinks, and take good care of that massive expense we call a mortgage.
Invest In Yourself
Working for the man gets old… Your tax refund can be used to start your own side hustle, or to invest in some personal or professional courses.
Consider your tax refund an investment in your ability to become independent of working that 9 to 5 job.
If you’re interested in photography, buy your DSLR and take a few courses. If you’re interested in cooking, invest in some quality equipment and take a course.
The point is, if you have a passion, there could be an opportunity to invest in yourself. This year’s tax refund could be the point you look back on in 5 years and think “I changed my life on that day”.
Invest your tax refund on your own growth. There isn’t really a better investment than yourself, right?
So, you didn’t quite nail your W4 and you got a tax refund this year. That’s ok. As long as you use the money in an intelligent, helpful way… the sting is eased.
Now, go see your CPA and get your W4 updated so you can enjoy that sweet cheddar each pay period and stop giving out interest free loans!
Let us know how you’re using your tax return in the comments! ↓