6 Ways a Tax Refund Could Brighten Your Financial Future
About 60% of American tax-filers expect to receive a tax refund this year, with the average refund amounting to just under $3,000 per person. While some tax pundits suggest reducing withholdings to make more of your money available to you throughout the year, many taxpayers look forward to tax season as an annual cash infusion.
This once-a-year refund represents both a potential risk and an opportunity. It could be risky because, psychologically, people tend to treat a windfall differently than they do expected income, and they are more likely to splurge on something frivolous than to pay off bills. But receiving a tax refund is also an opportunity to take a step toward improving your financial situation. By developing a plan for what you’ll do with your refund, you may be able to have fun and become more financially secure at the same time.
Live a Little
It’s human nature to want to spend money when you have it in hand, so to alleviate some of the temptation, why not set aside 10% of your refund to splurge on a guilt-free indulgence? Ten percent of a $3,000 refund would give you $300 to play with, which could get you a fancy dinner out, a new outfit, or a stress-relieving experience like a massage or a few rounds of paintball. Giving yourself permission to spend some of the money may reduce the temptation to spend it all and make it easier to be responsible with the majority of your refund.
Start an Emergency Fund
Most Americans would struggle to cover an unexpected $1,000 expense. A tax refund provides a great opportunity to start an emergency fund. Many finance experts recommend setting aside enough money to cover 3 - 6 months’ worth of living expenses so you can pay for future emergencies without going into debt. To avoid the temptation to dip into your emergency fund to pay regular bills, it may be a good idea to set this account up at a different bank than the one you use for day-to-day transactions.
Pay Down Debt
If you’re carrying month-to-month debt on a credit card, getting a tax refund is an opportunity to either pay off what you owe or reduce it. This could amount to significant savings and free up available credit for possible future needs.
An extra payment on a longer-term loan, like a mortgage or student loan, could save you a lot more than you think. A payment towards principal is like an investment with a return guaranteed to be the same as your loan’s interest rate. A single extra payment of $1,000, two years into a 30 year mortgage, would save you $2,973 in interest and contribute toward paying the loan off a few months early! This scenario assumes a 5% interest rate, but this calculator lets you play around with the numbers to see what your individual savings could be.
Make a Repair
Deferring a car repair could end up costing you much more in the long run. Oil changes, tire rotations, or that simple fix you’ve been putting off are all frustrating in the short term, but they could save you from much more expensive repairs later.
How much you end up paying by putting off simple fixes and routine exams can be even more dramatic when it comes to healthcare. Out-of-pocket healthcare spending spikes noticeably after tax refunds are issued. This can be a good time to see a doctor if you’ve been under the weather or putting off an exam. Your health is one of your greatest assets.
Fund an IRA
If you haven’t prioritized saving for retirement, you’re not alone. A tax refund provides a good opportunity to start, or add to, an Individual Retirement Account (IRA). These special accounts encourage retirement savings with tax advantages. A regular IRA allows you to deduct the amount you contribute from that year’s taxable income, which can reduce your taxes. A Roth IRA does not give you an immediate tax break, but all future income from this type of IRA is tax-free.
Turbocharge Your Side Hustle (or Main Gig)
Knowledge is power, which is why legendary investor Warren Buffett reads five to six hours a day. A tax refund is a great opportunity to take your side hustle to the next level. You could beef up your portfolio (or impress your boss) by taking a course to learn a new skill that makes you more marketable. Or maybe it’s time to beef up on tax law or business accounting so you can keep more of your money! You are your own biggest investment, and anything that helps you do a better job or makes you more in demand is money well spent.
Spring is a time for new beginnings, and a tax refund is an opportunity to make a new beginning for your finances. By splurging just a bit and investing the rest, you could make a big difference in your future.