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Given the average refund was $3,252 per taxpayer in 2022 (a 15.5% increase from the year before), tax refunds put a decent amount of money back into taxpayer’s pockets each year.
It’s important to remember that a tax return isn’t free money from the government. It’s simply a return of overpayment on your taxes. You paid more than necessary during the year so you get that money back.
When you think about spending it you want to treat it as money you worked hard for and diligently saved throughout the year. Think about your long term financial goals and use the money to get you one step closer to them.
1. Pay Off Debt
If you have debt, especially high-interest debt, this may be your first stop with your tax refund.
If you owe money to any family or friends, this is also a great use for your tax refund, even if they aren’t charging you interest you are paying for that loan in other ways. Let’s repair the relationship and get that paid off.
Next up, is your high interest-rate debts. Credit cards, payday loans, etc. Get those paid down as much as possible.
I’d especially be looking for debts that you can pay off completely. Get a motivation boost by eliminating some bills and freeing up some cash out of your monthly budget.
2. Build Up Your Emergency Fund
If you don’t have a fully funded emergency fund now is the time to give it a good boost.
The rule of thumb is to have six months’ worth of living expenses in your emergency fund. So if you don’t have that amount saved up your tax refund is a great way to give it boost.
This protects you in case of job loss, car repairs, medical emergencies, and just smooths out any cash flow problems you might have.
A high interest savings account is a great place to keep your emergency fund since you can actually earn a decent amount of interest right now. Here’s a list of our favorite high interest savings accounts.
3. Max Out Your Retirement Accounts
If you are debt free (or comfortable with your debt levels) and have a fully funded emergency fund the next place to put your tax return is in your retirement accounts.
IRA’s are a great way to save for retirement. There are two types, Roth and traditional. With a Roth IRA contributions you make today are not tax deductible but the money grows tax free and you’ll pay no taxes when you withdraw the funds in retirement.
With a traditional IRA you get a deduction on your taxes for any contributions this year and the money grows tax-deferred. You’ll pay income taxes on the money you withdraw in retirement.
In 2023, you can contribute up to $6,500 into an IRA. So if you haven’t maxed out your contributions for 2023 your tax refund is a great way to increase your contributions.
If you’ve already maxed out your IRA you may want to look into increasing your contributions to your 401(k). In 2023, you can contribute up to $22,500. Now, you can’t just directly contribute to your 401(k) like you could your IRA. Contributions need to come out of your paycheck. However, you can increase your payroll contributions and use your tax refund to reimburse yourself each week.
For example, let’s say you have a $3,000 tax refund that you want to put into your 401(k). If there are 15 paychecks left in the year you could increase your 401(k) contributions by $200 per paycheck. Then put your $3,000 tax refund into a savings account and schedule automatic transfer from savings to checking in the amount of $200 every two weeks.
4. Invest in a Brokerage Account
If you are saving enough for retirement and don’t want to (or can’t) increase your tax advantaged savings you can always invest outside of retirement accounts.
You have the entire world of investing options in a brokerage account. You can invest in mutual funds, index funds, etfs, individual stocks, crypto, and more. What to invest in is up to you, but if you are newer to investing I’d recommend a total stock market index fund. This will give you a little piece of every publicly traded company. It’s a good “set it and forget it” way to invest.
5. Invest in Real Estate
You don’t have to invest only in stocks and bonds. Real estate is another great option for those looking to diversify their investments.
You might be thinking, but how can I buy real estate with just my tax refund? The answer is fractional real estate investing. There are companies out there that will pool the resources of many investors and buy a property with each investor owning a slice. This allows you to get into real estate investing for as little as a few bucks.
There are several companies that do this type of investing and many different ways the deals can be structured, so make sure to do your research before jumping in.
6. Invest in Yourself
Is there a skill you could learn that would increase your salary? Investing in yourself will likely be the best investment you could ever make. If learning a new skill can get you a raise or promotion the ROI on the cost is immeasurable.
If you are self-employed a new skill could allow you to raise your rates or offer a new service that will increase your revenue. You could even take a marketing class or just learn how to run your business more efficiently.
Want to start a business? This cash infusion from your tax return might be what you need to buy that piece of equipment, or supplement your income while you go off on your own.
What I love about investing in yourself is that it’s about more than money. Sure, you might make more, but you may also be happier in your new job or working for yourself. And what is the point of money if we can’t use it to make us happier.
7. Do Some Home Improvements
If you own a home it’s likely your single largest asset. You’ll want to take good care of it. Not only will it make your house more pleasant to live in, but it may also make your home worth more when it’s time to sell.
Now, I’m not talking about replacing the perfectly good cabinets or remodeling a functioning bathroom. I mean fixing the broken sliding door or replacing the leaking faucet. Keeping your home in good condition can lower your repair bills in the future. A dripping pipe under the sink is $200 today but could be thousands if left unchecked and there is damage to cabinets and drywall.
Hire a handyman and give him a list. You’ll be surprised how many “honey-dos” he can get done in just a few hours and your house will thank you for it. Bonus points if your fixes are also more energy efficient and they lower your electric or heating bill.
8. Give to Charity
If you are in a position to increase your charitable giving your tax return can be a great way to do that.
Giving to charity is a wonderful way to make a difference in the world. If you are already giving to charity your tax refund can be a good way to boost that gift. If you don’t normally give to charity but want to you could donate all or part of your tax refund without having to dig into your monthly budget.
Keep in mind, you don’t have to donate to registered charity. Broaden your mind when it comes to giving. Is there someone in your life who could use a helping hand? Maybe there is a neighbor who could use a gift card to the local grocery store. Or a friend who needs a car repair done. You aren’t going to get a tax break on charitable donations unless you itemize anyways, which frees you up to give away your money in any way you want! Have some fun with it!
If you itemize you can also use your charitable giving to reduce your taxes, as long as the gift was to a registered charity.
The moral of the story here is to use your tax return in a thoughtful manner. Think about your financial goals and use this windfall to get you closer to them. No matter where you are in your journey you can do something useful with your tax return.