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Getting a tax refund isn’t a given. Some people submit their taxes only to see that they owe money to the IRS rather than the other way around.
But if you are the recipient of a refund this year, you have a prime opportunity to better your financial picture. Here are three of the smartest things you can do with that pile of money.
1. Build or boost your emergency fund
Did you know that most Americans couldn’t cover an unplanned $500 bill by dipping into their savings? So reports SecureSave, which also found that financial stress is hurting workers today.
If you don’t have enough cash in the bank to cover at least three months of essential living expenses, then make sure to put your tax refund directly into savings. It may not constitute a complete emergency fund, but it’s a good start.
Without an emergency fund, you might have to resort to debt when unplanned bills land in your lap. Similarly, if you end up losing your job through no fault of your own, you might have to charge your expenses on a credit card in the absence of having cash in the bank. And that could make an already stressful situation even more harrowing.
Now, chances are, your tax refund won’t be enough to cover a full three months of essential bills — unless it’s really large and your costs are pretty low. So don’t just stick that refund into savings and call it a day. Instead, aim to keep building on your savings until you’re covered for three months of expenses.
2. Pay off lingering credit card debt
Maybe you racked up a balance on your credit card during the holidays. Or maybe your credit card balance predates the holidays and was accumulated in 2022, when inflation ran rampant.
The problem with credit card debt is that the longer it lingers, the more interest you stand to accrue. In fact, let’s say you still owe $2,000 from the holidays, and your credit card has an 18% APY. Even if you manage to pay off that debt in a year, you’re still looking at wasting $200 in interest. Instead of letting that happen, see if your tax refund makes it possible to knock out your credit card balance for good.
3. Contribute to an IRA or 401(k)
There are a couple of reasons why it’s a good idea to use your tax refund to contribute to a retirement plan like an IRA or 401(k) plan. First, traditional IRAs and 401(k)s are funded with pre-tax dollars. If you contribute money to one of these accounts, every dollar you put in up to the annual limit set by the IRS is a dollar of income you won’t pay taxes on.
This year, IRAs max out at $7,000 for savers under age 50 and $8,000 for those 50 and older. With a 401(k), you can contribute up to $23,000 if you’re under 50 or $30,500 if you’re 50 or older.
So let’s say you get a $3,200 tax refund and put it into one of these plans. You could end up exempting that much income from taxes. If you’re in the 22% tax bracket, you get to save $704 on your 2024 tax bill.
Plus, IRAs and 401(k)s let you invest money for your future. Let’s say you contribute a $3,200 refund today, and your portfolio generates an average annual 10% return, which is in line with the stock market’s average. In 35 years, that $3,200 could be worth about $90,000.
Some people might argue that getting a big tax refund isn’t a good thing, since it means the IRS got to hang onto a lot of your money last year when you were entitled to that cash. But if you’re getting a refund, rather than bemoan that fact, put the money to good use. And specifically, focus on protecting yourself from unplanned bills, tackling credit card debt, and funding your nest egg.
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