Are you expecting a big tax refund this year? If so, how do you plan to spend it? Did you know that, according to the IRS, the average refund received by taxpayers in tax year 2009 was $2,994 (up from $2,836 in tax year 2008)?
That’s not chump change. If you are expecting as much, now is a good time to make plans for that money. If you don’t have a plan going in, it will be easy not to spend the money wisely. Here’s more info about your various tax refunds. Search the IRS’ website (updated once weekly) if you’re looking to track your Federal tax refund.
Up front I should say that if you have any type of financial goal (saving, debt reduction, etc.), now is the perfect time to take advantage of this large influx of cash to achieve your goals faster.
However, it’s not necessarily all about meeting financial goals. A good approach might also include using the tax refund for something fun and frivilous, or giving part of it away to your favorite charity.
As a side note, if you are receiving a large tax return, you should consider the fact that you are lending the IRS your money throughout the year, only to get it back without interest. Odds are you need to revisit your tax withholding by completing a new Form W-4 for your employer.
Here are a few ideas for making the most of your tax refund:
Establish an Emergency Fund – If you want to avoid debt or avoid raiding your retirement accounts in the event of a job loss or other financial emergency, then consider setting up an emergency fund. This fund will give you a cushion of cash to get you through a tough financial time. Most people aim to have about six months worth of living expenses stashed away in one of these funds. An ideal place for setting up an emergency fund quickly and without fees is at one of the many banks offering online savings accounts.
Pay Down Debt – If debt is causing you grief (and charging you high interest), then consider making a large payment on one of your debts. Pay off the account with the smallest balance or the account with the highest interest, which ever suits your debt reduction style. If it’s your mortgage debt you are prepaying, be sure to consider making a “principal-only” payment.
Complete Other Short-Term Savings Goals – Besides having an emergency fund, you may have other short-term needs for this money. These needs are usually expenses large enough not to fit into your normal monthly budget. Common short-term goals include:
- a car
- car repairs
- a vacation
- a motorcycle or boat
- a house down payment
- new furniture
- home improvements
- a new suit/wardrobe
Instead of dipping into debt to fund these purchases, use your tax refund.
Retirement Savings – Another great place to use your tax refund is in your retirement accounts. You could put more money into your 401(k) at work. However, many people use their tax refund to open up and fund a new IRA. This is a retirement account, typically separate from your employer, where you control what your investments are. There are tax advantages to doing this as well. It’s possible that by investing in a Traditional IRA before you file, that you could even increase your tax refund.
College Savings – Use the funds to open up a 529 College Savings Plan for your child. The money invested in a 529 savings plan grows tax free as long as it’s used on college expenses. The funds in most “savings” type plans (vs prepaid plans) can be used at any college or university in the U.S..
Go Back to School – Invest in yourself by using your tax refund to return to school. Finally get that undergrad degree, or aim for a graduate degree. This investment will ideally pay you back in the future.
Start a Business – Use the excess cash to fund a startup business. Nothing says you are serious about a new business like putting up your own capital to get it off the ground. This is a much better option than getting into debt or asking your parents for money.
Give it Away – If you didn’t miss the money all year, then maybe you don’t need it. Maybe there is someone else, or some organization, that needs it more than you. If you do give a portion of it away, consider giving it to a qualifying charitable organization. The donation will likely be deductible on next year’s return.
What will you be spending your tax refund on? Let us know in the comments below.