No one likes paying taxes, but we all like it when we get a nice refund from the IRS. It feels like free money, so it’s easy to wind up blowing it or using it inefficiently. But in this article, we’ll look at ways to use your tax refund productively.
Although a tax refund may feel like free money, it definitely isn’t. Getting a big tax refund just means that you paid more taxes than you needed to throughout the year, and you essentially gave the government a free loan.
If you get a big refund every year and you’d like to take home more of your pay throughout the year instead, you can adjust your withholding by filling out a new W-4. Contact your employer’s Human Resources department if you need assistance.
Now that we’ve got that covered, let’s move on to the fun part of the topic – how to use the money that you’re getting from the IRS!
Ok, so a lot of the suggestions in this article may not really be that exciting or glamorous, but if you want to use your money responsibly these are all good options. Your future self will thank you.
→ Related reading: How to Create a Budget that Works
10 Ways to Use Your Tax Refund
1. Fund Your Emergency Savings Account
One of your top financial priorities should be to have a savings account that is set aside specifically for emergencies. If something unexpected happens, like being laid off from work, the emergency savings fund may be what helps you to get by and to avoid excess debt.
Most experts recommend that you have enough money in your emergency fund to cover 3-6 months of living expenses. If you’re self-employed, have an unpredictable income, or if you’re a single-income family, being at the higher end of that range is a good idea.
If you don’t have an emergency savings fund, or if you don’t have enough in your emergency savings, a tax refund is the perfect way to quickly address the issue. Many people struggle to build up an emergency, so use this opportunity to give yours a jumpstart.
You can open an online savings account with a high yield to have your money safe and convenient to access if you need it quickly.
I highly recommend a high-yield savings account or money market account with CIT Bank. My wife and I have our emergency fund with CIT because the interest rate is more than 20x the interest rate on the average savings account!
2. Pay Down Debt
Do you have credit card debt? If so, paying off that high-interest debt should be a priority. Rather than going out and spending the tax refund on something you don’t need, consider paying down or paying off your credit card debt using the debt snowball or debt avalanche approach.
Credit card debt tends to be high interest, but there are other debts that you might want to pay off with your tax refund. You could also pay down student loans, car loans, or uneven pay down on your mortgage if you’d like.
→ Related reading: The Realities of Mortgage-Free Living
3. Home Improvements
If you’re a homeowner there are probably several projects that you would love to do, it’s just a matter of having the money to do them. A tax refund is perfect for using for that home improvement that will make your home more comfortable or increase the home’s value.
There are endless possibilities here. It could be something simple and inexpensive like buying some paint for the walls, or it could be a bigger project like new flooring, a bathroom renovation, or landscaping improvements.
You could also use the money for new appliances, which can even help you to save money on utilities in some cases.
→ Related reading: The True Costs of Owning a Home
4. Use it for a Necessary Purchase
Is there a big purchase that you know you’re going to need to make in the next year? Maybe your car is on its last leg and you know you’ll be replacing it soon. Why not use the down payment for a new or used car?
Are you expecting a baby in the next year? If so, there are plenty of things you’ll need to spend money on. Why not set up a savings account dedicated to expenses for the baby?
Are you anticipating any medical bills that won’t be covered by insurance (for example, Lasik surgery)?
Most of these things are something you would be spending money on regardless, so why not use the tax refund to offset some of the cost?
5. Individual Retirement Account
IRAs are a great way to save for retirement. It could be a Traditional IRA that will reduce your taxable income, or a Roth IRA. The Roth IRA won’t reduce your taxable income but will grow tax-free, and should be a priority unless you are over the income limits to be eligible to contribute.
You can open an IRA with any number of companies. I have mine with Vanguard and I’ve been very happy with them.
For 2020, you’re eligible to contribute up to $6,000 to an IRA if you are a single tax filer with a modified adjusted gross income of $124,000 or less, or married filing jointly with a modified adjusted gross income of $196,000 or less. If you’re over 50 years old you can contribute up to $7,000.
→ Related reading: 9 Steps to Financial Independence (How to Retire Early)
Aside from an IRA, there are plenty of other investment options as well. I would suggest an IRA first as long as you’re eligible, but if you’ve already contributed the maximum to an IRA or are not eligible, look at other investment options. Stocks, mutual funds, real estate, and alternative investments are all options.
If you’re looking for a way to invest, there are a number of apps that make it very easy. See our article Robinhood vs. Stockpile vs. Webull to compare three of the leading options.
7. Donate to Charity
If your tax refund feels like free money, why not use it (or part of it) to help someone else? There are countless charities out there that would love to have your money. Pick one that supports a cause that is important to you.
If you have kids, consider involving them in the process of selecting a cause or organization to support. In the past, my wife and I have asked our kids to choose something out of World Vision’s gift catalog that they wanted to support. It’s a great chance to have a good conversation with your kids about money and how we can use it to help others who aren’t as fortunate.
This year my wife and I are using part of our tax refund to support The Exodus Road, an organization that fights against human trafficking.
Maybe you have a family member who is really struggling financially or had some major setbacks. You could always help them out instead of giving the money to a charitable organization, although you won’t get the nice tax benefits.
8. College Savings
If you have kids, you may be interested in helping them to pay the insanely high costs of a college education. Start a 529 plan, or add to your existing plan if you want to use your tax refund to help prepare for your child’s future.
9. Start a Business
This is one of my favorite options on the list! Invest in yourself and use the money to fund a business idea or side hustle that you’d like to pursue. Of course, some businesses are too expensive to start with your tax refund, but there are plenty of options for businesses that don’t cost a lot of money. Buy some inventory and start selling on Amazon or eBay. Get web hosting and start a blog. There are plenty of options. Your investment in your business could lead to a huge payoff if your business is successful.
Read more about some of our favorite business ideas:
- How to Become a Bookkeeper
- How to Start an Etsy Shop
- How to Sell on eBay for Beginners
- How to Start a Handyman Business
10. Take a Vacation
Using your tax refund for a vacation may sound like a splurge, but we all need some time off. A nice vacation can be just what you need to be refreshed and recharged. Vacations, obviously, are also a great way to spend time as a family.
The cost of taking a family on vacation can get quite expensive, depending on where you go and what you do. Using your tax refund to pay for all or part of your vacation is a good way to have a nice vacation without breaking the bank.
What’s Your Choice?
How are you going to use your tax refund? Feel free to leave a comment below.