Smartest Ways to Spend Your Tax Refund
March 1, 2016 : Laura Adams – Guest Contributor
According to the IRS, almost 80% of taxpayers get a federal income tax refund—and the average amount is around $2,800. That’s a big chunk of change! Before you spend it on a shopping spree or booking a cruise, consider how it could improve your personal finances instead.
Saving might not be as much fun, but it can be the key to creating long-term financial security. Here are five tips for the smartest ways to spend your tax refund.
Tip #1: Build your emergency fund
One of the best financial safety nets you can create is a cushy emergency fund. It can get you out of tight spots, such as losing your job, needing an unexpected car repair, or getting a large medical expense that your insurance doesn’t fully cover.
A good rule of thumb is to keep at least three to six months’ worth of your living expenses in an FDIC-insured savings account. If you don’t have that much in reserve, make sure building your emergency fund is a top priority for your tax refund.
Tip #2: Buy insurance
Having enough of the right kinds of insurance is important for keeping you and your family safe. If you don’t have key policies, consider using your tax refund to pay premiums.
The Affordable Care Act requires most individuals not covered by an employer’s plan, Medicaid, Medicare, or other public program to purchase health insurance or pay a penalty.
If you have a spouse, children or others who depend on your income, it’s ideal to also have ample life and disability policies. Life insurance pays one or more of your named beneficiaries a lump sum if you die. And disability pays a percentage of your monthly income if you get sick or injured and can’t work.
Tip #3: Fund a retirement account
Investing through a tax-advantaged retirement account is a smart way to create future financial security. If you have a 401k, 403b or 457 plan at work, increase your payroll contribution and use your tax refund to make up any shortfall in your budget.
You could use a refund to build or start an IRA. If you’re also covered by an employer’s retirement plan, your tax deduction for a traditional IRA depends on how much you earn and your tax filing status.
Remember that there may be tax penalties for withdrawing money from a retirement account before the age of 59½. So be sure to put money in an IRA only after you’ve established an emergency fund and are sure you won’t need the money.
Tip #4: Pay down high-interest debt
If you have a healthy emergency fund, but also have expensive debt—like high-interest credit cards, retail store cards or payday loans—use your tax refund to pay them down.
Reducing or eliminating debt cuts your monthly interest payments so you can save more money.
Tip #5: Fund a college savings account
If you’re saving money for your own education or for your children’s education, consider putting your tax refund in a 529 savings plan. Funds in a 529 grow completely tax-free if you spend them on qualified education expenses such as tuition, books and computer equipment.
Getting Your Tax Refund
Want to directly deposit your tax refund into multiple accounts, such as a bank savings and an IRA? No problem. Just submit IRS Form 8888 with your tax return.
If you get a big tax refund year after year, you may need to adjust your withholding so less tax is deducted from your paychecks. Use the Tax Withholding Calculator for help completing a new Form W-4 and submit it to your employer.
Start filing for free online with H&R Block.