Are you trying to figure out the smartest ways to spend your tax refund this year? Considering the economic effects of the pandemic, you might be wondering how you can put those funds toward your long-term financial goals. Below, we've compiled expert tips for applying your refund according to your needs.
Pay down your debt
According to Andy Wigzell, a financial planner with Barnum Financial Group, there are two schools of thought around paying down debt. "The first is tackling the high-interest debt first, even though you might not pay it off entirely. The other, which I find more personally successful for clients, is knocking off one bill at a time in full even if it's not high-interest debt,” he explains.
When it comes to spending your refund check, you might be better served paying down a balance on a high-interest credit card (typically considered to be 14 percent or more) or personal bank loan than low-interest debt (like student loans). That's because paying down high-interest loans first can save you more money in the long-run by eliminating those high-interest charges. Alternatively, it may make sense to pay off a bill in full, if you can. “It can feel incredibly rewarding to pay off a bill entirely,” Wigzell notes. Think about which option might be best for you.
Build your savings account or emergency fund
A refund check can be a smart way to create an emergency fund to help pay for unforeseen circumstances, like home and auto repairs and medical emergencies.
“You should have enough money on hand to prevent you from having to use a credit card to stop the boat from leaking," Wigzell says. If you haven’t set up an emergency fund, consider putting a sizable portion of your refund aside to build one.
In regards to building your savings, Wigzell recommends a two fold approach: Putting the bulk of your money into liquid accounts, like a money market or high-yield savings accounts, so you can have access to your funds when needed (while earning some interest), and investing a smaller portion in the stock market may make sense. You may want to consider investment options like dividend-yielding stocks, which can help provide you with steady cash while they’re in your portfolio. Talk to a financial advisor (another smart investment for your refund!) about customizing a financial plan for your needs.
Create a college fund for your kids
The average cost of raising a child until the age of 18 in the United States is nearly $285,000! This doesn’t include the cost of college, which on average can range from more than $11,000-$41,000 annually for tuition and fees alone, according to data for the 2020-2021 school year.
If you’re looking to start (or grow) your family, it may make sense to keep a sizable portion of your refund liquid in a savings account to cover family expenses. The remaining funds could go to a higher education savings plan: Both 529 savings plans and Coverdell Education Savings Accounts are designed to build funds for higher education with certain tax advantages.
With a 529 plan, beneficiaries have access to funds that grow and can be withdrawn tax- and penalty-free to cover the costs of higher education, and most states allow you to deduct at least a portion of the amount you invest in the plan as long as it is in your state of filing. Coverdell ESAs are similar to 529s but also allow you to withdraw funds to pay for K-12 education and supplies.
Wigzell cautions that no single funding source will likely cover all education expenses. “People tell me they would like to put $100 a month into a 529. That's fantastic, but you'd have to put in a hundred dollars a month for the next 162 years to pay for [college] tuition!” he notes. Therefore, savers should also consider whether to allocate some portion of their college fund into more aggressive investments and hold them over the long-term. Your financial advisor can explain your options.
Invest in your retirement
It's always a good idea to save for retirement, helping you make the most of your tax return by investing in your future.
If you’re less than 10 years away from retiring, now is the time to take advantage of catch-up contributions to your retirement accounts, like an IRA. The IRS allows people 50 years of age or older to contribute an additional $1,000 per year to a traditional or Roth IRA account. Using your refund check to maximize your IRA contribution still makes good financial sense no matter how close—or far away—you are from retirement, Wigzell says.
As a rule of thumb: “Make sure you're getting the employer matching contribution maximum [in your employer sponsored retirement plan]. And maximize your Roth IRA deposits," he explains. "Once you've done that, if you have money left over from your return, invest in an asset that pays a good dividend.” Talk to your financial advisor to discuss your options.
One more thing: If possible, don't forget to set aside some money for having fun. Because that's important, too. And it may be the investment you look forward to most.