Few people look forward to tax season. But for many, there is one upside: getting a refund. The average refund hit $3,053 in 2016, according to the IRS.
Thousands of extra dollars in your pocket might have you dreaming of booking a luxury vacation abroad or buying the latest gizmos. But while these fantasies are fun to entertain, you need to take a realistic look at your financial situation to determine whether your tax refund would be better put toward financial needs.
Here's a look at ways you can use your refund to your long-term benefit, rather than for a short-term thrill.
Pay Down Your Debts
In a survey of 3,000 adults, GOBankingRates.com found that the median mortgage debt among Americans is $59,500, making it the largest source of debt in the U.S. Student loans came in as the second largest, with a median $9,100 owed. Auto loans came in third, with Americans saddled with a median debt of $8,000.
To combat debt, use your tax refund to pay down balances. It will help relieve pressure put on your wallet by interest charges and increase your financial freedom. Even if you can't pay off a balance in full, reducing your required minimum payment can help you avoid falling behind when money gets tight.
Further, lowering the amount you owe can help you relieve stress as you draw toward your goal of being debt free. After all, paying off debt is the No. 1 cause of financial stress.
Pad Your Emergency Fund
Having three to six months' of expenses saved up in an emergency fund is a good rule of thumb. Unfortunately, few Americans are putting away enough money in savings to manage emergencies, like an unexpected car repair or medical bill, or unemployment. In fact, according to one GOBankingRates survey, 69 percent of Americans have less than $1,000 in savings.
If your emergency fund could use a bit more cash, put most, if not all, of your refund into savings. If you have a habit of dipping into savings from time to time, open a separate savings account at a bank you don't frequent, and keep your emergency funds there. That way, the only way you can access your funds is by visiting that particular bank.
Check Out: 10 Best Savings Accounts of 2017
Invest Your Refund
If you've decided to save your tax refund, contribute to a 401k or IRA, or other investment vehicle. Even a refund of $500 or less can be put toward investment options like individual stocks, mutual funds and dividend reinvestment plans, to earn you money over time.
If you're a more conservative investor, consider a certificate of deposit. A three- to four-figure refund is more than enough to satisfy the minimum opening deposit requirement for this type of savings vehicle. With a CD, your money will earn higher interest than you'll see in most savings accounts. In exchange, you'll keep your money locked in for a set number of months or years.
Invest in Yourself
One way to get guaranteed returns on your refund is by investing in yourself. Learn new skills at a community college, sign up for personal development seminars or buy fitness gear and sessions with a personal trainer. You can even use the windfall to help fund a side project, like a small business venture or Etsy store.
But if you're really raring to spend a little money on entertainment or material goods, don't shy away from a financial cheat day. In a February 2016 article for U.S. News, financial expert Josh Felber wrote that cheat days can help you avoid overindulgence.
A little bit of spending here and there helps you scratch that itch you get when you want to make an impulsive purchase. So, go ahead and buy yourself a new shirt or take a frugal vacation on your refund — just don't go overboard.
Make Home Improvements
You don't have to gut the kitchen to invest in your home. Small fixes to keep your home in prime condition can help you avoid more expensive repairs in the future. Further, simple upgrades, like a new dishwasher or wood flooring in the living room, can modernize your home and make it more appealing to buyers.
Home improvements you make can come with tax benefits when you sell your home for profit. That's because upgrades are added onto the tax basis of your home. For example, if you purchase a home for $300,000 and make $50,000 worth of upgrades while you own it, you'll subtract a $350,000 basis from the final sale. So, if you sell your house for $500,000, you'll only pay taxes on $150,000 of it.
Make a Charitable Contribution
Your tax refund might be your only opportunity to make charitable contributions each year. And not only is it personally fulfilling to give money to those in need, but acting selflessly can make you happier. Plus, if you donate money to a qualified charitable organization, you can reduce your taxable income and lower your tax bill for next year.
If you're not sure which organization you should donate to, use resources like Charity Navigator and Charity Watch to research the most trusted nonprofits. You can learn how an organization manages its funds, like how much goes toward administrative expenses and fundraising. That way, you know your money is going to a worthy cause.
John Csiszar contributed to the reporting for this article.