What to Do With Your Tax Refund

What to do with your tax refundIt’s almost April, and that means taxes are on the brain! In 2011, more than 100 million Americans received a tax refund, with the average refund equal to a cool $2,913!

No wonder many people at this time of year are wondering what to do with their tax refund. Are you expecting to get a refund this year? If so, then you’ve come to the right place, because we are about to give you 6 great ideas for what to do with your tax refund.

But first, let’s get one thing straight: it’s better to not get a tax refund. Why? Because getting a tax refund means you paid more taxes during the year than you needed to, and so the “tax refund” is the government’s way of paying you back. While it’s nice to get a lump sum from the government, the downside is that you’ve essentially loaned that money without getting anything in return. If that money had not been withheld from your paycheck throughout the year, you could have either invested it (and earned interest) or paid off debt (and avoided paying interest on it).

I think you can see where this is going… the smart financial move is to adjust your income tax withholdings so that the amount taken out of each paycheck is more accurate. To do this, use the handy IRS Withholding Calculator. Of course, adjusting your withholdings means in the future you’ll get your money throughout the year rather than in a tax refund at the end of the year. But for now, let’s look at the best ways to use your tax refund this year.

Now that we’ve got that clear, here are 6 ways to use your tax refund in 2012 to get closer to reaching your financial goals:

1. Use Your Tax Refund to… Top Off Your Emergency Fund

You thought since ReadyForZero is dedicated to helping you get out of debt, we’d put that #1 on this list, didn’t you? As it turns out, there is one thing you must do before you pay off your debt – and that is to ensure you’re prepared for unexpected expenses or life events that could change your financial picture in the blink of an eye. Without an emergency fund, things like losing your job, having your car break down, or having sudden medical costs will cause you to rack up even more debt.

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So before you do anything else with your tax refund, do a quick reality check on your emergency fund: Do you have one? Is it funded properly? Would you be able to survive on it if necessary? Experts generally recommend that your emergency fund should be at least $1,000 – and that if possible, you should have anywhere from 1 to 6 months of living expenses saved up. If you feel that your emergency fund is currently on the verge of extinction (or nonexistent) use your tax refund to give it new life.

2. Use Your Tax Refund to… Pay off Your Debt!

Alright, we couldn’t put this one lower than #2, could we? Here at ReadyForZero we are all about helping you get out of debt as fast as possible. And what better way to speed up your journey than putting your tax refund toward your debt? Whether you have a credit card with a 25% APR, medical bills, an auto loan, or a student loan (or all of the above) your situation will look way better if you pay off a big chunk of that debt. By funneling your tax refund toward paying down your balance(s), you’ll essentially be strapping a giant rocket-booster onto your get-out-of-debt plan. We’ve seen this strategy work incredibly well for people.

Just be sure to pay off the debt that has the highest interest rate first. That way, you’ll get the most bang for your buck, because you’ll save more interest in the long run and you’ll get out of debt even faster. If you’re not sure which debt has the highest interest or how to make sure you’re paying off the right one first, just log in to your ReadyForZero account (or if you don’t have one yet, click here to sign up).

3. Use Your Tax Refund to… Invest in a Roth IRA

If you don’t have one of these, now might be a good time to start one. A Roth IRA enables you to save for retirement, and it does something that almost no other investment can do: it allows you to pay zero taxes on the money that you earn through interest on your initial investment. What that means is you could put $5,000 in right now and, assuming you earned 7% on it for the next 20 years, you’d end up with $20,000! And that’s with no further investment on your part! Most importantly, you’d be able to take the money out (when you’re ready) without paying taxes on it.

Now do you see why so many people recommend starting a Roth IRA? If you already have an emergency fund and have paid off all your debt, then using your tax refund to start or add to a Roth IRA is probably one of the smartest things you can do. No matter how big or small your tax refund may be, it can grow into a very significant amount of money by the time you’re ready to retire. (And technically, it can double as a backup emergency fund)

4. Use Your Tax Refund to… Invest in Yourself

One of the most interesting things you could do with your tax refund would be to expand your own career opportunities by attending an industry conference or enrolling in a training or certificate program you’ve been wanting to do for a long time. This might be something that could help you advance in your current job, or it might be something that could help you get a new job in the future. For example, if your expertise is in finance, you could take a course to become a Certified Financial Planner. If you want to develop your expertise with computers, you could take a computer programming course or do an IT training program. Or if you’ve always wanted to sell real estate, you could get your real estate license.

Remember, your tax refund is a once-a-year opportunity, so it’s wise to think of it as a way to accomplish things you’d normally have trouble doing. In some cases, all that’s standing between you and a chance to re-define your career is a few hundred dollars. Even something as simple as learning how to use social media to help you reach out to potential clients or customers could pay off big time. So don’t be afraid to invest in yourself!

5. Use Your Tax Refund to… Buy Something

Yes, it’s okay to spend a portion of your tax refund! Especially if you have already done the things listed above. But rather than just spending randomly, think about what would be likely to make you happy in the long run. You should be purposeful about buying something that you really need, such as a long-needed repair for your car (radiator, bumper, tires, etc.) or your house (roof, paint job, tiles, etc.) or yourself (massage, personal trainer, vacation, etc.). Don’t feel bad about treating yourself – sometimes doing small, nice things for yourself is a perfect way to keep your motivation and stay focused on your financial goals.

The beauty of this type of spending is that it will be satisfying to you and it will probably save you money in the long run. Being physically healthy and having a house and car in good working order are preconditions for being financially healthy – not to mention being happy, period.

6. Use Your Tax Refund to… Give to Charity

One of the most rewarding things you can do is use your own financial resources to help others who are in need. Of course, not everyone is in a position to do this, but if you are, it’s likely something you won’t regret. There are many ways to give. You could give to a local food bank or your local branch of Habitat for Humanity. You could give to a national or international organization, such as Unicef or the Red Cross. If you choose to give to a large organization, it’s always recommended that you check them out on a site like Charity Navigator to make sure they are legitimate and that they will use your money in appropriate ways.

There are literally thousands of options (maybe even millions), so just do your research and decide which charity is a good match for you.

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No matter which of these options you choose to use your 2011 tax refund on, you will make savvy financial choices as long as you make purposeful decisions and consider the long term consequences of your decisions. Oh, and by the way, if you’re wondering where your tax refund is, try the “Where’s My Refund?” tool from the IRS website.

And if you want to get out of debt faster, try our free online tool that allows you to easily make a plan for paying off your debt:

» Try ReadyForZero

This article is part of our Budgeting Tips Resource Center.  If you’re looking for additional information about budgeting tips, be sure to pay a visit!

Image 1 credit: 401K

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  • Zack Jones

    #7 Use your refund to pay for your 20 year wedding anniversary trip :). That’s what we’re doing. It’s nice being able to say that our upcoming trip is already fully paid for.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      I love it! I’m smiling just thinking of you guys enjoying your trip together while knowing that it is completely paid for. Where are you planning to go?

  • http://carefulcents.com/ Carrie Smith

    I did all of the above. :) I put the majority towards my debt (since I already  have an emergency fund), put 1/4 into my Roth IRA and used the last 1/4 as a little spending money! I love tip #4 too, about investing in yourself and career.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      That’s so cool! I think allowing for 1/4 to be spending money is perfect because it makes you feel like your hard work has a purpose (and helps keep you motivated). When will you post your next debt goal update?

      • http://carefulcents.com/ Carrie Smith

        My next goal update for March will be posted on Saturday. It was a rough month, but I think it might all turn out okay! Mostly thanks to the tax refund too.

        • http://www.twitter.com/bwfeldman Benjamin Feldman

          Nice! I’m looking forward to reading it.

  • http://sean-weston.hpage.com/ Joseph Kottow

    If I get a tax refund, it will be going in my emergency fund/tuition fund/insurance fund. I have a lot of expensive things to pay for this year!

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      That’s a great plan, Joseph. Using the extra cash to save up for things you’ll need, like tuition, is exactly the right way to go.

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  • charleen

    I will save my tax rebate to pay taxes on my house since i am laid off but i want to fix my bathroom it needs alot of work

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      That is a good idea – paying the taxes on your house is something that you’ll need to do no matter what, so it’s better to use the lump sum to get that done. And hopefully the bathroom will get done too!

  • Margaret

    I am lucky to have a rather large sum of money sitting in a savings account making practically no interest, this will increase with this year’s tax return. I have been debating whether to use these monies to reduce my mortgage substantially but I have been told that this is not the best way to go and I should look at investing the monies instead. My mortgage interest per month is $500+ and there is no where I can get that kind of money each month in interest by investing the large sum I have sitting in my savings account. What are your suggetions?