What to Do With Your Tax Refund

Alden Wicker
Posted

If there’s one upside to doing your taxes, it’s the refund that you might get once you file.

True, it’s actually your money that you’re getting back. But it’s still a cool feeling to get a check for a couple thousand in the mail from the government. 

This year, 85% of Americans expect to get an average refund of $2,803. So what should you do with that mini-windfall? We got the lowdown from LearnVest Planning Services certified financial planner ™ Rachel Sanborn on how she advises her clients to use this little bonus from Uncle Sam.

1. Have Some Fun

First, take 10% of your refund and do something fun with it. Research shows that most people bump up their spending when they get a refund, even if they plan to save it all. So you might as well make it official and guilt-free. Go to dinner at an amazing restaurant, buy a fun new pair of sunglasses or spend a nice spring day at the amusement park. Really, whatever you want—just be sure to stick to the 10%. (After all, there is a right and a wrong way to splurge.)

2. Get Closer to Retirement

Now you’ve got 90% of your refund left. If you’re not maxing out your retirement options, take some or all of your refund and put it toward that big life goal. It’s almost always the best use of your dollars.

If you don’t know yet in what order you should be contributing to your retirement accounts (or which accounts you should have), then click on the flow charts below, single or married depending on how you file your taxes.

Put your tax refund to the first account listed for you until you run out of refund, or you reach the maximum contribution on the account. (If a 401(k) is your first account, see below.) IRAs can take lump-sum contributions, so you can send a big check to your IRA, if that’s your first account. Keep in mind that IRAs have an annual contribution limit of $5,500 per year (even if you have two types of IRAs, you can only contribute $5,500 between the two accounts).

If a 401(k) is your top account, you can’t make a lump-sum contribution, so you’ll just increase your 401(k) contributions temporarily (keeping in mind that annual 401(k) contributions are capped at $17,500), and then use the refund to make up for the difference in your paycheck. After you’ve used up the refund, be sure to lower your contributions again.

In either case, if you have money left over, you can put the money toward your second priority account, or move on to the next steps.

RELATED: Retirement, Savings or Debt? How to Prioritize Your Financial Goals

3. Get Ready for Emergencies

Are you already on track to retirement? Without your emergency fund stocked up, you could (or more accurately, will) face a situation that will force you to throw an expense on your credit card. So your savings account is your next step. Do you have at least six months of living expenses in a savings account just in case? If not, throw your refund in there to get closer to that goal.

what do do with your refund

4. Pay Off Credit Card Debt

By now, that refund is probably all accounted for. But if not (that’s either impressive finances on your part or an impressive refund), here’s your game plan: Tackle any balance you’re carrying on your credit cards. Use what LearnVest calls the “Avalanche Method.” Start with the card with the highest interest rate first, and then work your way down until all credit cards are paid off.

RELATED: I Want to Create a Plan for Paying Off Debt

5. Pay Down Private Student Loans

If you’re on track for retirement, have your emergency fund all set and have your credit card debt wrapped up, your next step is to bring down the balance on any private student loan debt you have. We’ve specifically called out private loan debt, because it often has a higher interest rate than federal loans, and if your income were ever to drop, you would have a harder time convincing the lender to lower the payments. (With federal loan interest rates so low, we’ll get to them later.)

6. Put It to Other Goals

Everyone saves more when they have a goal in mind. So what is on your wish list? Home renovations? A dream vacation? Now is your chance, if you have refund money left, to add to your “big life goal” fund, and get a bit closer to making it a reality.

RELATED: Why I Would Never Buy a New Car

7. Pay Down Federal Student Loans

Finally, if you really want to and you still have cash, send that check straight back to the federal government—but this time, to pay off your federal student loans. We’ve put this last, because federal student loans often have low interest rates and affordable payments. Plus, unless you have a high income (an adjusted gross income of more than $75,000 if you’re single and $150,000 if you’re married filing jointly), you can deduct the interest.

Hey, if you couldn’t get to everything on this list, that is quite all right. You can use this order for any windfall that comes your way, from a birthday check to a bonus. So save this for later. And HAPPY END OF TAX SEASON!

  • Amy

    Why would you not pay off debt before building your emergency fund? I have about 3 months of living expenses in my emergency fund, but I have credit card debt about the same amount as my emergency money.

    For the sake of examples, let’s say I have $10000 in my emergency fund, $10,000 in credit card debt, and a $5000 return on the way.

    I had planned to send the $5000 tax refund to my credit card, theorizing that I can cut that debt in half and pay off the debt sooner. After I’m debt free, I would convert my credit card payments to “emergency savings payments” until I get $20,000 or more in my emergency fund. Is this a bad idea?

    • K

      Depending on the interest rate of the debt, it might make sense to build an emergency fund before paying the debt entirely off. For example, if you have no savings and $5k in credit card debt, a $2k return would be more useful in a liquid savings account, especially if you do end up needing it for a medical emergency/job loss/etc. sooner than anticipated. Once a small emergency fund is established, extra funds can be used to pay down debt, but being debt free is of little use in the event of an emergency.

  • Austintatious

    Alden, I’m thinking that you’ve left off one of the best possible options. That’s using one’s refund to purchase I bonds, one of the safer “investments” guaranteed to keep up with inflation. After 12 months when the funds must remain in the government’s coffers, one can consider their I bond purchases either long-term investments, or an emergency fund, or both. All the while, the money keeps pace with the inflation rate, plus it grows at an additional rate set by the government. And it’s all backed by the full faith and credit if the U. S. And one can use her refund to purchase paper I bonds, which are even easier to redeem than the “electronic” bonds purchased from Treasury Direct, online.

  • Cao Rainy

    I get my tax refund through tax software, mostly the software has deals on AnyCodes during tax season. If the refund from Sam exceed $5000, I’d deposit $2000 in my bank account, and the others are for shopping and other expenditure.