7 smart ways to use your tax refund
When a tax refund is set to bring extra cash your way, it's important to give some thought to how you'll use it. You could splurge a little—or you could use the money to fund some of your financial goals. If you're expecting a tax refund this year, here are a few of the best ways to put it to work.
1. Build your emergency fund.
Having money in emergency savings can be reassuring if you have an unexpected expense. Rather than draining your checking account or turning to a high-APR credit card, you can use your emergency fund to cover it.
If your emergency fund is running low, you could use your tax refund to give it a boost. Or you could use your refund money to start your emergency fund if you don't have one yet. Aim to save three to six months’ worth of expenses.
2. Contribute to an IRA.
An Individual Retirement Account or IRA offers a tax-advantaged way to save for retirement. Traditional IRAs offer a deduction for contributions while Roth IRAs allow for tax-free distributions in retirement.
As of 2022, you can contribute up to $6,000 to either type of IRA. (A $1,000 catch-up contribution is allowed for those 50 and older.) The IRS makes it easy to use your tax refund to make IRA contributions. You can simply open your IRA, then schedule a direct deposit of your refund.
3. Pay off debt.
Debt can be a roadblock to investing more money for retirement or saving toward your children's college costs. If you're expecting a refund from your taxes, you could use it to eliminate some of your debt.
When deciding which debt to pay, consider what will make the biggest impact on your finances. You may be tired of paying on your student loans, but if you also have a credit card balance with a high APR, it makes more sense to pay down the high interest debt first.
4. Save for education expenses.
After buying a house, paying for your child's college education may be one of the largest investments you'll ever make. Your tax refund could be used to fund a 529 college savings account on your child's behalf.
Using a 529 plan to save offers some advantages. Growth is tax-deferred, and withdrawals are tax-free when the money is used for qualified education expenses. All 50 states offer at least one 529 plan, and you can choose any state's plan to save.
5. Invest with a brokerage account.
An IRA can help you save for retirement, but it's not the only way to invest. You could use some of your tax refund to open a brokerage account or fund an existing one.
Brokerage accounts can offer a wider variety of investment options, including stocks, mutual funds, and bonds. You can build a diversified portfolio and grow wealth in addition to the money you might be saving in an IRA or your workplace retirement plan.
6. Create a sinking fund.
If you're already saving toward your main financial goals and debt is under control, you may decide to use your refund to create a sinking fund. A sinking fund is designed to hold money for planned expenses or large future purchases that you don’t want to pay for in a single month’s budget. Use it to give extra breathing room with your monthly budget or for semi-regular expenses:
Open a high-yield savings account and link it to your checking account so that you can auto-transfer funds each month.
7. Invest in yourself.
Investing in yourself may not offer an immediate return, but it can be one of the best ways to use your tax refund. For example, taking courses to learn new skills could pay off if it helps you get a promotion or raise at work. Or you may use the skills you learn to start a side hustle or small business and increase your income. Or perhaps you have a personal goal that these funds can help you finally achieve.
Remember, a tax refund isn't free money; it's your own money given back to you at the end of the year. But regardless of how you decide to use it, having a plan can help you make the most of your tax refund.