5 Smart Ways to Spend Your Tax Refund to Build Wealth
- If you’re getting a tax refund this year, consider using it to build wealth instead of splurging.
- Use it to pay off credit card debt and student loans, or beef up your emergency savings.
- Or invest it in a retirement account or brokerage account. After all that, treat yourself.
The deadline to file your 2021 taxes was April 18, so unless you filed for an extension, you’ve likely filed your 2021 taxes by now. Whether you used a tax-filing software, accountant, or did them yourself, the hard part is (mostly) over. Depending on how much you withheld or paid throughout the year, you either owe money or will receive a refund.
If you paid too much in estimated taxes or withheld too much from your paychecks, you’ll likely receive a tax refund. This year’s average refund so far is $3,226 — that’s quite the chunk of change!
If you have already received or are expecting to get a refund this year, you may be thinking about what to do with the money. Before you run out to make a big purchase, I’d like to recommend stepping back and making a plan.
As a financial planner, I’m a fan of balancing long-term goals over short-term rewards. Sure, using your tax refund to buy a new pair of shoes or luxury vacation sounds great in the moment, but it’s important to weigh the instant gratification of splurging with the long-term benefit of setting yourself up financially for the next year and beyond.
A refund (or any windfall!) is a great chance to kick-start a money goal or improve your financial situation. Here are my five favorite ways to use your tax refund.
1. Boost your emergency fund
Emergencies can happen at any time. Some are one-time expenses — a sudden medical bill or home repair — and others are longer-term, like job loss.
This is what makes having emergency savings so essential. An emergency fund can help you avoid borrowing money to cover costs. If you don’t have an emergency fund, your refund is a great place to start. I recommend having around six months’ worth of expenses, including the amounts you spend on necessities like rent, food, utilities, and gas for your car. But remember — any amount saved is better than nothing at all.
Store your emergency money in a savings account that’s easily accessible, but separate from your checking account. This prevents you tapping it for everyday expenses.
2. Pay off debt
Credit card debt is one of the most nefarious forms of debt, thanks to high interest rates. If you have an overdue balance on your card, use your refund to pay it off (or as much as you can).
If you have student loan debt, you can use your refund towards repayment. The pause on federal student loan repayment was just extended through August 31, but you should consider paying — the pause also set your loan’s interest rate at 0%, which means any payment you make now through August 31 will go directly to the principal of the loan, reducing your overall loan faster and reducing the amount of future interest you’ll pay. A win-win!
3. Put more towards retirement
Retirement is one of the largest goals you’ll work towards throughout your life. If you’ve fallen behind with retirement savings, your refund is a great opportunity to make a one-time deposit in your 401(k) or individual retirement account. In 2022, you can contribute up to $20,500 to a 401(k) and $6,000 for traditional and Roth IRAs.
While it may not be the most exciting way to spend your refund, your future self will thank you.
If you’re already on track to meet your other financial goals, consider using a portion of your refund to invest in the stock market. Investing is a great way to grow your wealth over time, and while the stock market may seem a little bit like a roller coaster right now, remember that ups and downs are normal.
Depending on your investing time horizon and appetite for risk, there are tons of investing options available. If you’re more risk-averse and want to take a “set-it-and-forget-it” approach, consider investing in index funds or an exchange-traded fund, which are typically automatically diversified. If you want to get more involved with your investments, consider shopping for individual stocks. There are also plenty of robo-advisors out there to help you get started.
5. Treat yourself
While I’m all about paying for your financial future first, don’t be afraid to reward yourself a little. It’s totally OK to treat yourself to something new with your tax refund, as long as a majority is still going to those larger financial goals.
If I receive a tax refund, I typically set aside around 10% to buy myself a nice dinner out or a new item of clothing. I consider it as a mini reward for using most of my refund towards other goals. Positive reinforcement is a real thing, and splurging a little can help reinforce those positive financial habits.