According to Forbes, it’s best to adjust your withholdings so that you don’t get a tax refund at all. A refund means you overpaid your income tax. When you overpay, you involuntarily loan money to the government free of charge. The refund is just the IRS paying you back without interest — try and see if they’ll allow you to do the same with them.
Even so, millions of Americans look forward to tax season because it often comes with a big infusion of cash. The average refund in 2020 was $2,741, enough money to make a real change for many families — if they use it wisely. Here’s how you can make for a brighter 2021 and beyond with a few wise choices when the IRS finally does get around to paying you back.
Fight the Urge To Splurge
Everyone is coming off a tough year and you probably have every excuse to use your refund for some good, old-fashioned consumer indulgence — but consider not doing that. Your refund can either be a life-changing financial seed or a down payment on a Jet Ski or a hot tub, a higher trim package on a new car or a flurry of Amazon purchases, but it can’t be both. It’s perfectly human to splurge on refund day — but only a little. Order the big sushi platter that they make for two people and eat it yourself. But after that, think about your future.
Make a Plan
If you blow your refund on a curved 4K TV that takes up your whole wall, at least you have something to show. What’s worse is if your refund is deposited into your checking account, gets mixed up with all your other money and bleeds out slowly and unaccounted for through daily life and expenses. When you file your returns, make a plan for your refund so you’ll be ready for your money when it arrives. Segregate it in a special account until you figure out exactly what and how much you’re going to spend, save and put aside.
Attack Credit Card Debt First
2020 saw an unprecedented drop in credit-card utilization as balances plummeted by an average of 14% across all generations. Delinquencies dropped sharply and utilization hit a 10-year low, according to Experian. That’s because skittish Americans wisely used their stimulus checks to pay down credit-card debt instead of making new purchases. It’s a miraculous silver lining in an otherwise dreadful year. If you have credit card debt, you should follow their example — there are few better ways to spend your refund. High balances on high-interest revolving loans are kryptonite to credit scores that trap borrowers in endless cycles of minimum payments and new finance charges.
Learn More: 11 Steps for Paying Off Credit Card Debt in 2021
Tackle Installment Loans Next
If your credit cards are in good shape, the next best thing you can do is put your refund toward the principal on any installment loans. Even if you can’t pay off the whole thing, you’ll pay off your loan sooner and spend far less on interest over time. Installment loans include:
- Mortgage loans
- Auto loans
- Student loans
- Personal loans
Start or Build an Emergency Fund
It’s impossible to overstate the importance of an emergency fund to get you through a few months in case of the unexpected. 2020, if nothing else, was proof of that. It’s so important, in fact, that it’s worth earmarking a chunk of your refund to a dedicated emergency fund even if it means leaving some of your toxic credit-card debt intact. Most Americans couldn’t weather a $1,000 emergency and a frightening percentage has no emergency savings at all.
Buy an Index Fund
Everyone knows that if you put $2,000 or $3,000 into Amazon at the beginning, you’d be rich. The truth, however, is that regular investors are incredibly bad at successfully picking individual stocks over time. Yes, even you. That’s why Warren Buffett has been recommending index funds for decades. They offer the diversity of mutual funds without the fees and expenses with the convenience of being bought and sold in shares on the open market like common stock. If you have money left over from your refund, your debt is under control and your emergency fund is where it needs to be, buy an index fund, contribute to it regularly and watch it grow.
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