Most people dread filing their tax returns, even if it means that they will be getting money back. The process of preparing your taxes is enough to take the pleasure out of getting a refund. If you are expecting a refund this year, you should think about what you plan to do with that money that you are getting back. Some finance experts recommend that you adjust your withholdings so that you get to keep more of your money up front, rather than lending it to the government all year. However, some people feel that planning for a refund is a foolproof savings plan for them. It forces them to set money aside and not touch it until the government returns it the following spring. Whether your refund is large or small, you should take a look at these five smart ways to use your tax return.
1. Pay Down Debt
One really smart way to use your tax return is to pay off credit card debt. The notoriously high interest rates on credit cards can cost you a bundle every year. Even if your tax return isn’t enough to completely pay off your credit cards, you can use it to make a dent in your credit card debt. This will save you money every month and amount to big savings in the long term. If you pay off just $1,000 in credit card debt with your tax refund, you’ll save hundreds of dollars in interest fees. Using your tax refund to pay off credit card debt will save you more money than any other option for using your tax refund.
2. Fund Your Emergency Savings
Another great way to use your tax refund is to set up an emergency savings account. When you have your credit card debt paid off, you can strengthen your financial position by building an emergency savings fund. Finance professionals recommend that you have at least three months’ salary in an emergency fund, although six months’ salary is even better. With a secure emergency savings fund, you can avoid financial pitfalls when the unexpected happens. If you lose your job or suffer some other crisis, you’ll have the funds on hand to deal with these problems. You won’t have to rely on credit cards, which will rack up finance charges, or borrow from a 401(k) and pay penalties.
3. Save for Retirement
If your credit cards are paid off and you have a well-funded emergency savings fund, consider putting your tax refund into a retirement account. Even if you all ready have a 401(k), you can still invest in a Traditional IRA or a Roth IRA.
4. Invest in Real Estate
You can take advantage of your tax refund by investing in real estate. If you currently own a home, you can make extra payments to pay off your mortgage early. First, make sure you won’t face prepayment penalties. If you don’t own a home yet, this is a good time to buy. Home prices are still low, interest rates are historically low, and you can get a loan that requires a down payment of only 3.5%.
5. Start a College Savings Fund
Use your tax refund to start saving for college. Even if your children are very young, it is never too early to set up a college savings plan. A Section 529 plan lets you prepay for college costs. A Coverdell Education Savings Account is a tax-deferred option for saving for college.