10 smart things to do with your tax refund

If tax season gives you anxiety, you’re not alone. All that paperwork isn’t most people’s definition of fun.

But filing your taxes can sometimes come with an exciting reward: a juicy check from Uncle Sam.

While it’s not technically free money (it comes from overpaying on your taxes), getting a refund check that’s worth a couple of thousand dollars — or even a few hundred — feels great.

However, it’s super easy to spend that money on frivolous things (last year, I spent a chunk of mine on a tattoo, for example). And while there’s nothing wrong with spending it on a bit of fun, using that money wisely can help you get ahead, financially speaking.

Here are 10 smart things you may want to do with your tax refund.

1. Build an emergency fund

“Life happens and unexpected expenses occur,” says Ashton Lawrence, a financial advisor at Goldfinch Wealth Management. 

“If people don’t have the funds to pay for those unexpected expenses, this can result in taking on debt.”

That’s why he recommends using a portion or all of your refund (depending on your financial circumstances, of course) in a savings account. Having three to six months’ worth of expenses saved up is typically the go-to rule for anyone in the personal finance industry.

You have a couple of options when it comes to storing your emergency fund:

• High-yield savings account — These accounts do exactly what they sound like they do: offer a much higher yield (interest return rate) on your savings than typical checking or savings accounts. See our picks for the best high-yield savings accounts.
• Money market account — While savings accounts don’t come with check-writing privileges (they’re meant for saving, after all), money market accounts do, while also offering higher interest rates than regular old savings accounts. See our picks for the best money market accounts.

Read more: Everything you need to know about emergency funds

2. Pay off debt

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This is likely your least favorite suggestion since none of us want to think about our debt. But if you have high-interest debt, you’re better off spending your refund check paying it down, as this will free up more of your income and save more money in the long run, Lawrence says.

This is especially true if you have credit card debt or private student loans, as these tend to carry higher interest rates when compared to other lending products.

Paying off debt can also improve your credit score and your debt-to-income ratio or DTI, which is a percentage that measures how much of your monthly gross income is compromised by your debts, and is the metric most mortgage lenders use to approve you for a loan. So, if you’re in the market for a house, this could do wonders for you.

You’ll predominately hear about two debt-payoff strategies:

• Snowball — The snowball method involves paying off your debts from the smallest balance to the largest balance. This gives you some momentum and helps keep you motivated to continue paying off your debt.
• Avalanche — The avalanche method involves paying off your debt that has the highest interest rate first so you don’t pay way more in interest than you need to.

Read more: 10 ways to get out of debt on your own

3. Put money toward your retirement account

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Lawrence says that one of the best ways to spend some or all of your tax return money is putting it toward your retirement account, especially a Roth IRA, which is easy to max out (with contribution limits of $6,000/year).  

“This will allow the funds to grow tax-deferred and qualified distributions to be tax-free.”

If you don’t yet have a retirement account, here’s our beginner’s guide.

And to learn more about Roth IRAs in particular, check out Roth IRAs for young adults: Why starting early pays off.

4. Invest in the stock market

If investing your tax refund in a retirement account is a little too boring for you, you could go for stocks or mutual funds.

If you’re not sure where to begin, you can opt for an automated portfolio with a robo-advisor.

Robo-advisors are diversified account investors that use a complex algorithm to best manage your investments. Note that you will need to pay fees for the robo-advisor, but those fees will be substantially lower than fees you’ll pay for a financial advisor. See our picks for best robo-advisors.

If you’re into a more hands-on approach, then an active investment portfolio may be a good choice for you.

With an active investment portfolio, you can choose your own investments, whether that’s stocks, bonds, mutual funds, or exchange-traded funds (ETFs), among other options. This also allows you to be pickier about the companies whose business you want to support.

Read more: Beginner’s guide to the stock market

5. Use it to save up for a major purchase

OK, if you’re one of the lucky few who don’t have debt and have a good thing going on with your savings, then you can stash some of your extra money into your bank account (a high-yield account, of course) to help you save for a bigger purchase, like a house or a car.

But if you want to see your money grow a bit more than it would in a bank account — and don’t foresee needing it in the near future — you can also put the funds away in a certificate of deposit (you can find the best CD rates here).

6. Make an extra payment on your mortgage

If you already own a home, get one step closer to fully owning it by putting that money toward your mortgage.

Every penny counts and depending on the size of the lump sum you want to add, you could end up recasting your mortgage — that is, changing the amortization schedule of your loan. Your lender will change the payment schedule to update the principal and interest.

Keep in mind that lenders usually require $5,000 or more to recast a mortgage.

Read more: How to pay off your mortgage early

7. Give your home or car some TLC

If you’ve been putting off some much-needed home improvements, like fixing a leaky roof or upgrading your bathroom or kitchen, now may be the perfect time to get some of those fixed.

This will not only improve your quality of life but can potentially increase your home’s value. In other words, it’s a win-win.

Another great way to spend your tax return money is using it to repair your car. According to a survey by Ally Financial, Americans spent close to $2,000 over the course of five years in car repairs, while nearly 4 in 10 said they would not be able to cover an unexpected expense of $400 without having to sell something or go into debt.

So, if your car’s dashboard looks like a Christmas tree, you may want to use your refund to give it the maintenance it needs.

8. Invest in yourself

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Are you craving a career change but don’t know where to start? Or maybe you want to climb the career ladder but lack the skills. 

If that’s the case, then you may be better off using your refund to attend a boot camp, get a certification, or take a stackable credential to help you further your career. 

Although some courses can cost a couple thousand, platforms like edX and Coursera offer affordable courses in the low hundreds, and even free ones you can check out.

Read more: Ways to invest in yourself

9. Start a business or upgrade an existing one

The pandemic brought with it a small business boom. Last June alone, Americans started over 440,000 businesses, according to NPR.

So, if you’ve been wanting to become an entrepreneur for a while, you can use your tax return cash as seed money to start financing your new venture (whether that be starting a freelancing career or a brick-and-mortar store).

Likewise, if you already have a business and your equipment is getting kind of rusty, or your website could use some help from a designer, that’s also a smart way to invest your money.

Read more: How do you know you’re financially ready to start a business full-time?

10. Support a cause that’s close to your heart

In the unlikely event that there isn’t anything you want in this world nor do you have any debt to take care of, another great use for your refund check is to donate part of it — or all of it, if you’re feeling extra generous — to a charity of your choice.

Besides helping others and building good karma, you can use this to your advantage, as the IRS allows taxpayers to deduct these contributions. However, the charity you choose must meet the IRS’ eligibility requirements for you to make that move, so make sure you check with the entity first, if you’re planning on taking advantage of this over the next tax year.

Read more: 4 reasons to give to charity

Summary

Getting your tax refund can feel like free money, but it’s not. You actually worked pretty hard for it.

Whether you invest it, save it, use it to improve your home, or use it to pay off debt, the most important thing is that you use it wisely and don’t throw it away on things you don’t need.

Featured image: IhorL/Shutterstock.com

Read more:

• Tax return error? Here’s how to amend your return
• What documents do I need to file taxes?