Tax refunds can be used for a number of practical purposes, like paying down debt or building your savings. However, refunds can also be blown on things you don’t really need. The good news is many Americans make smart choices with their money — and you can, too.
When it comes to your tax refund, are you planning to save it, pay credit card bills or spend it on a big-ticket item? Planning not only when and how you file your taxes is just as important as how you’ll invest your money if you’re expecting cash back from the IRS.
With that in mind, let’s examine the biggest mistake you can make with your tax refund along with how to avoid it.
Don’t Make This Mistake
With an estimated two-thirds of people planning to use their tax refund for practical purposes, that leaves about one-third who might make the biggest tax refund mistake — blowing it on frivolous or unnecessary things, such as an expensive vacation or a new car you don’t need.
There are much better ways to use your tax refund so that the money works for you instead of against you. For example, putting your refund into a high-yield savings account means the money will grow at a solid and predictable rate while also being protected by the Federal Deposit Insurance Corporation (FDIC).
Putting your tax refund into a savings account can help you build wealth for the future, especially if you can find ones with APYs nearing 5%. In contrast, blowing your refund on something you don’t need or won’t use could put you in a deeper financial hole.
Look at the Big Picture and Make a Plan of Action
One way to avoid this tax-refund mistake is to make a list of your financial goals and how you expect to achieve them. This will help you look beyond immediate gratification and focus on steps that can bolster your financial situation.
Here are a few options to consider:
- Bills you need to pay now: Ideally, you won’t use your tax refund to pay bills that you should be paying with your regular income. But if you are behind on some of your bills and find it hard to catch up, it’s fine to use part of the tax refund to get current.
- Revolving debt: Credit card debt is one of the biggest roadblocks to financial security — and getting rid of it is one of the best financial moves you can make. Don’t be afraid to use your tax refund to pay off credit cards.
- Other debt: If you have other debt, such as a car loan or student loan, you might want to use part of your tax refund to get ahead on those. Doubling up your payments can help pay them off faster. Just make sure there’s no penalty for doing that.
- Short-term savings goals: If you don’t already have an emergency fund, then a tax refund is a great way to get started on one. You should aim to build a fund that can cover at least three to six months’ worth of expenses in the event of a sudden job loss or unexpected expense. If you already have an emergency fund, then list some other short-term goals, such as saving for a car or mortgage. Set up separate savings or CD accounts for these items and use your tax refund to fund them.
- Long-term savings goals: No matter your age, it’s never too early to set money aside for retirement. Investing your tax refund into an IRA or other type of retirement savings account can pay dividends down the road. If you have young children, you might also put a priority on saving for their college education. In this case, consider investing some of your tax refund into a 529 plan or similar college fund.
- Investment goals: It’s important to maintain a balanced portfolio that includes not only bank and retirement accounts but also stocks, bonds, mutual funds and other investments. Using your tax refund to balance your portfolio through stock, bond or mutual fund investments is another smart move.
Caitlyn Moorhead contributed to the reporting for this article.