According to the Internal Revenue Service's eFile website, 2019 saw over $450 million sent to Americans in the form of tax refunds.
The average household refund was $2,781. This influx of capital is an excellent opportunity for individuals and families to set themselves up for a brighter financial future.
All it takes is a little planning and discipline. Without an immediate need or plan for those funds, it can be easy to blow the money on impulse purchases.
Careful planning for that extra money will ensure that it continues to build toward goals such as getting out of debt, saving for a large purchase, updating a home, and more.
There are a plethora of ways to utilize a tax refund that consumers never consider.
While the advice of financial professionals is the easiest way to find the best way to spend a tax refund, some basic areas should be considered.
Read on to find often overlooked areas where a refund can help.
Table of Contents
- 1. Pay Down Debt
- 2. Establish an Emergency Fund
- 3. Contribute to A Retirement Fund
- 4. Seed a College Fund
- 5. Invest In the Stock Market
- 6. Kickstart Your Career
- 7. Launch a New Business
- 8. Make Home Improvements
- 9. Buy Life Insurance
- 10. Pay It Forward
- 11. Treat Yourself
- Conclusion
1. Pay Down Debt
One of the single greatest areas that a refund can come in handy is in paying down debt.
According to the Experian Debt Study, overall consumer debt in the United States reached a record high of more than $14 trillion in 2019.
Moreover, lugging around high-interest debt that compounds monthly is one of the greatest weights around the neck of American consumers.
Debt comes from several sources but the most common are revolving credit card accounts and loan balances for a home or automobile as well as student loans.
Paying down the amount owed on these accounts is akin to saving money in that it allows the consumer to get out from beneath the debt sooner.
This, in turn, allows those minimum payments to be freed up for other purposes.
Crafting a debt payoff plan is essential to a person's financial health if they hold outstanding high-interest debt.
Plan to pay down one debt at a time and start with the ones that cost you the most in interest which is generally going to be that credit card debt.
Credit cards
The Experian 2020 Consumer Credit Review reports the average credit card balance of American consumers is more than $5,000.
Even at low-interest rates, that balance would take more than a decade to pay off at the minimum payment amount.
Even if a refund is not enough to completely pay off a credit card, it can pay the balance down to a more manageable point.
Along with some adjustments to how much is withheld each pay period, a person can get out from under the debt faster and avoid paying thousands in interest charges.
Using our credit card payoff calculator, can help you determine how fast a credit card balance can be repaid.
Student Loans
Student loan balances in the U.S. averaged more than $38,000 in 2020.
If the borrower is making minimum payments at a 6% interest rate, it will take more than a dozen years to repay the principal and roughly $23,000 in interest.
As with credit card debt, using a tax refund to pay a large chunk all at once can eliminate some of the additional interest paid as well as reducing how long this debt cuts into an individual's regular income.
Working with a financial expert to find ways to reduce the amount withheld per pay period can free up additional funds that can be used to speed this process up even more.
Personal finance expert Anthony O'Neal provides a handy student loan payoff calculator on his website that can help determine how much applying a tax refund in this way can help.
Home & Auto Loans
Experian's Consumer Credit Report lists the average American auto loan balance at $19,703 while the average mortgage balance was $208,185 in 2020.
While a $2,500 tax refund may seem insignificant when facing a debt as large as that of a mortgage, like with credit cards and student loan debt, every little bit helps.
News reports the average interest rate for auto loans in January 2021 was 10%. Mortgage rates generally hover around 3%.
With the large principal financed by these loans, those interest charges can add up.
Reducing the total amount owed by paying down a home or auto loan with a tax refund can offset a portion of this additional cost.
The vehicle loan and mortgage calculators we offer, can help consumers get a more accurate understanding of how these debts affect their bottom line.
2. Establish an Emergency Fund
Putting away that tax refund for a rainy day is another good way to make sure that it is used wisely.
By using the extra money provided by a refund to seed an emergency fund, consumers can create a financial cushion if the unexpected should happen. And it always does.
Without an emergency fund, sudden expenses like major automotive repairs, medical emergencies, or loss of income can create a financial crunch.
Consumers are often forced to secure high-interest short-term loans or tap into credit cards to cover these costs.
Diving further into debt without a life preserver.
Financial experts often recommend that:
- Salaried workers have three to six months' salary – nine to twelve months for self-employed or gig workers – put aside for funding these emergency savings.
However, a tax refund is a great way to get started.
3. Contribute to A Retirement Fund
Saving toward retirement is another excellent way people can save their tax refund. After all, that money was part of their paycheck in the first place.
Augmenting or purchasing an individual retirement account (IRA) will isolate those funds for use in the future. If one's debts are caught up and they have a starter emergency fund established, saving money for when they no longer are working is the next best option.
Even if a person only saved a $2,500 tax refund toward retirement every year, they would have a nice nest egg of $75,000 after 30 years to fall back on.
Consulting a retirement planning expert can help determine how to best save for the future.
4. Seed a College Fund
It is never too early to start saving for a child's education. According to EducationData.org, the average cost of college in the U.S. is $32,889 per year and it grows by 5.2% annually.
Consumers can do themselves – as well as the children in their lives – a huge favor by starting to save for this inevitable expense early.
Using a tax refund to establish a college fund can help to offset an expense that is responsible for a large percentage of American debt, student loans.
Some state income taxes even allow for a deduction for funds used for this purpose.
5. Invest in the stock market
While the stock market has seen many fluctuations in recent years, it has historically provided for a higher return on investment than bonds, certificates of deposit (CDs), or savings accounts.
If there is no immediate financial need for the funds, and the above areas are financially stable, investing a tax refund in the stock market provides the opportunity for growth toward larger financial goals.
Although the stock market can be risky, a successful investment can help you to realize large gains that can then be utilized to fund your future goals. Even if you only make small gains, they are likely to be greater than those realized through traditional savings.
6. Kickstart Your Career
Another great way a person can invest their tax return is by increasing the value of their human capital.
That is, to invest it in themselves.
The reputation, experience, talent, expertise, and education a person brings to the table all impact their biggest income-producing asset… themselves.
By using a tax refund to finance furthering their education or expanding their training, people increase their value in the workforce.
This investment pays off in the long-term with promotions, greater job stability, and larger paychecks.
Moreover, the U.S. government offers a Lifetime Learning Credit that may be used as a deduction on future taxes.
7. Launch a New Business
Starting a new business does not require extensive business plans, consultations with financial experts, or high-interest loans.
It can be as simple as buying a little inventory with a tax refund and setting up a simple online store or eBay account.
If there is a side hustle that brings in a little extra cash, there is no reason that cannot become a full-fledged side business with the investment of a tax return as seed money.
If somebody already has their own business, reinvesting in it with a tax refund can help them grow that business to the next level.
You can consult with our business financing experts if you need help you with your business.
8. Make Home Improvements
Buying a home is one of the largest investments most people will make in their lives. If all other areas are financially stable, reinvesting in a home through improvements can be a great way to spend a tax refund.
Moreover, it can cut down on the daily expenses involved with operating that home.
Here are a few home improvements you can make:
- Replace old appliances - old appliances are a drain on electricity and can be replaced by newer models with higher efficiency.
- Add insulation - adding insulation to the walls of an older home will reduce the heating costs in colder months.
- Replace windows - replacing windows with newer, more efficient models can improve the effectiveness of heating and air conditioning which lowers energy costs.
- Remodel the bathroom - for homeowners looking to sell, remodeling the bathroom can increase the sale price by up to 40% alone
- Remodel the kitchen and landscape - landscaping and kitchen remodel are also known to add value to homes on the market.
If nothing else, sprucing up an abode can make the people that live there happier. That alone is a good reason to invest a tax refund into a home remodel.
9. Buy Life Insurance
Nobody likes to think about dying but it is an inevitable part of every life.
While it can be easy to overlook the need for life insurance – especially when young – it is an important financial consideration.
This is especially true for those who have dependents.
A life insurance policy provides a financial safety net if the worst happens. Most policies can be started for only a few hundred dollars and provide the security that those left behind will be able to maintain their standard of living.
10. Pay It Forward
Sadly, one of the last areas people consider when they receive a tax refund is charity. If all the areas above are covered, donating a tax refund to a worthy cause offers numerous benefits.
In addition to the warm feeling, giving provides, most charitable donations are tax-deductible.
Thus, donating is self-propagating by allowing for a larger refund the next year.
11. Treat Yourself
If you are financially stable in all other areas, consider treating yourself to one of those big purchases you have been denying yourself.
Take a vacation somewhere you have always wanted to go. Build yourself a she-shed in the backyard to escape to. Buy season tickets for your favorite sports team.
The best way to avoid blowing money on impulse purchases is to allow yourself to enjoy a few treats when you can afford them.
Conclusion
As January rapidly rushes toward February every year tax time closes in. By the first of March, Uncle Sam is sending out refunds to those who were ready for it.
By developing a strategy for tax time, as well as what to do with your tax refund, you will be ahead of the curve.
Consulting an experienced tax professional will ensure that deductions are optimized for the best possible refund. Every year, Americans leave money on the table through missed credits and deductions.
Plan for your financial future with expert advice from our professionals at 121 Financial Credit Union in Jacksonville, FL.
Call us at 904-723-6300 or complete our online contact form and one of our friendly professionals will contact you. If you are interested in learning more about healthy financial habits, visit our Learning Center page.