With your tax refund lining your pockets, it’s tempting to empty them as soon as possible. While treating yourself to new gadgets and clothes would be a fun way to celebrate your return, it’s not the best use of your money in the long-term. When the average refund is $2,640, this chunk of cash is better used in practical ways.
Not sure how you can use your tax refund responsibly? Here are four ways to protect your check from impulse spending.
1.Pay off credit cards and personal loans
Your wallet and credit score will thank you if you use your tax refund to pay off as much of your credit card balance as possible. It doesn’t matter if you can’t clear it entirely — any reduction in what you owe will pay off — literally.
With most credit cards charging roughly 19 percent in APR, you’ll “earn” back 19 percent on your payment. In other words, your credit card balance will accrue less interest.
This quick payment may also improve your credit score. Part of your score is calculated by how much of your available credit you use. When you’re able to lower how much you have on your credit card, you’ll use less of this available credit. This looks good to creditors.
Paying off other loans, including payday loans and installments loans, will also help you maintain your credit score. The biggest difference between payday and installment loans is their repayment schedules, so you can save a lot of interest if you pay them earlier than their due date.
2.Set up an emergency fund
Many of the reasons why so many people rack up considerable credit card debt boil down to the fact they don’t have an emergency fund. This special savings fund is there to help you when things go wrong — helping you take on necessary repairs, unexpected charges, and medical emergencies.
Some financial advisors recommend having at least six months’ worth of wages saved. An emergency fund this large will help keep you afloat should you encounter a sudden loss of job or illness that prevents you from working long-term.
A tax refund of any size will help your emergency fund last longer in the face of an emergency, so consider preparing for the unexpected.
3.Build a college fund
Parents can expect to spend more than $233,000 on raising a child — and this doesn’t even include the astronomical cost of college tuition.
If you thought you had big student bills to wrestle with as a freshman, just think of what your children might face! According to one estimate, a single year of higher education at a private school will cost more than $120,000 in 16 years, while one year of tuition would cost roughly $54,000 at a public college.
To help them offset the cost of their tuition, you can invest your tax refund in a 529 plan. These qualified tuition plans let your money grow at a higher interest rate than most basic savings accounts. It also comes with some significant tax benefits, including unmatched income tax breaks.
4.Think about your retirement
Juggling your child’s future with your own is a smart bet when it comes to your tax refund. It’s also a practical option if you don’t plan on having kids. After all, most people intend on retiring at some point — regardless of their family life.
There are a variety of retirement plans available, but few are as popular as a 401(k) or Roth IRA. Both of these accounts have limitations on how much you can contribute in a single year, so make sure you won’t surpass the threshold for your income level. Remember to check in with your HR department to see if your employer matches your contributions, as this is a quick way to double your savings.
Just like a specialized college fund, retirement savings often come with tax benefits, including reducing your taxable income.
Bottom line: be responsible
The IRS doesn’t regulate how you spend your tax refund — it’s totally up to whether you spend it on impulse purchases or invest it in your future. Ultimately, it’s up to you to weigh the pros and cons of either option.
If you’re due a reward for sticking to your budget and filing your return on time, then, by all means, use some or all of your return on something fun. But in all likelihood, your finances would benefit by a responsible use of your refund, so consider these four tips carefully before you decide.