What You Should Do With Your Tax Refund

Should you use your tax refund on a big-ticket item like a MacBook, designer apparel, a musical instrument, or a wall-sized TV?

If you’re tempted, I understand. Getting a tax refund can feel like the IRS just dropped free money into your account.

Why not treat yourself to something cool?

But that’s not true. Your refund is your hard-earned money. It was your money all along. The government took more than you owed in taxes all year. Now it’s paying you back.

If you like the idea of using your earnings to get ahead in life, your refund — whether it’s a few hundred dollars or a few thousand — can go a long way toward giving you more freedom in the future.

And with more freedom, you can unlock more spending power throughout the year and not just when your refund comes through.

How You Should Spend Your Tax Refund (If You’re Smart)

Of course, nobody should tell you how to spend your money.

If you’d like your refund to pay for a weekend-long shopping spree (and you and your family aren’t hungry or homeless), that’s your prerogative.

You earned the money.

My job as a financial advisor is to make recommendations that could pave the way to a more stable financial future for you and your family.

With that in mind, here are some of my favorite, and some of the most responsible, ways to spend your tax refund.

With all these ideas I am assuming you already have an emergency fund set aside with at least three months worth of living expenses. If you don’t, you should use your refund to create one.   

1. Reduce High Interest Debt

Being in debt to a credit card or another unsecured lender can bleed you financially. Think about this common scenario: a $2,000 credit card balance at 26.99 percent interest. By making the minimum payment, you’ll spend about $3,800 paying off that $2,000.

Using your refund to pay off the entire $2,000 balance right now could save about $1,800 in finance charges. And you’d be avoiding future rate increases or late charges that could drive the balance even higher.

If you have more than one card with a high balance, pay off the one with the highest interest rate since higher rates cost you more over time.

It’s not only about credit cards:

• Maybe you have an unsecured loan from your neighborhood bank.
• Or maybe you’d love to get that car paid off.
• What about those student loans that just won’t go away?

Putting your tax refund onto the principal of a higher interest loan will save you money in the long run.

Being in debt makes it much harder for your money to work toward your future. Your money can’t work for you because it’s working for someone else: your creditors.

Your tax return can help turn this around.

2. Grow Your Refund In an Online Savings Account

Are you doing OK on the debt front? If so, your refund could provide a great way to start saving for the future.

While you could just transfer your refund money directly into savings, you can unleash stronger earnings with a more strategic approach

An online-only savings account at a bank like CIT Bank can pay you a much higher interest rate — sometimes 10 times higher than your neighborhood bank.

Your $2,000 refund would gain several hundred dollars worth of interest in a year in a high-yield account. 

3. Build On Your Refund With a CD

Want even more interest on your saved refund? A Certificate of Deposit (CD) can deliver. Typically, longer-term CDs offer the highest savings rates, but even short term CDs are gaining high returns historically.

At the end of the CD’s term, you can cash out or renew your CD to generate even more interest.

Whether you choose an 11-month CD or a five year one, each year, this year’s tax refund would grow even larger.

A CD is a great place to invest safely, keeping you from spending your return too hastily and earning you interest simultaneously.

4. Start Investing with Your Tax Refund

The risk of losing your refund is astronomically low when you save it using any of the methods above.

Investing your refund puts your money at more risk, but it also opens up the possibility of earning much more.

Here are some of the safest ways to invest:

• A robo-advisor: Robo-advisors such as M1 Finance, Wealthfront, and Betterment can invest your money in diverse funds without charging high brokerage fees or requiring you to know exactly what you’re doing. Start investing with M1 Finance>>
• Fundrise: Fundrise lets you invest in real estate development without being a developer or having the responsibility to actually manage anything. Start investing with Fundrise>>
• Lending Club: You’re the banker when you invest in Lending Club, which issues loans to individuals and small businesses. As your borrowers repay, you’ll earn from the interest they’re paying. Start investing with Lending Club>>
• Your own home: A refund of a few thousand dollars could go a long way toward a down payment on your own home, or at least closing costs. If you already own, check out the next section.

5. Invest Your Tax Refund in Your Future

Why not consider investing this year’s tax refund into your long term goals?

The money you earn from this year’s tax returns could be a stellar starting point for your retirement account, for instance.

A Roth IRA, for instance, is one of the most rewarding retirement accounts you can invest in.

If you foresee yourself having higher taxes at retirement than you do now, a Roth IRA is perfect.

Online brokerages are a great option for Roth IRAs, streamlining your retirement and providing resources to keep you on track to meet your goals, and Ally Invest is one of our top picks.

Open a Roth IRA with Ally Invest>>

6. Use Your Refund to Improve Your Home

Homeowners probably won’t be able to get a new roof or build a garage with their tax refund.

But your refund could still improve your home in ways that add value to your property:

• Fresh landscaping: Curb appeal helps sell homes, and new landscaping could also help you enjoy your yard more. Your refund could buy an outdoor sitting area, a new patio or walkway, or new shrubbery, for example.
• New bathroom fixtures: Realtors say better bathrooms move homes faster. Maybe some new light fixtures, a new vanity, or a better exhaust fan will fit into your refund amount.
• Under-counter lighting: Your kitchen may be the room with the most potential for adding value to your home. New appliances can help if you need them; new features like under-counter lighting, a new island, or better storage could add even more value.
• Insulation or windows: While home maintenance may not add value directly to your home, getting better insulation or a few new windows with your tax refund will save money on heating and cooling.

7. Use Your Refund to Get Ahead In Life

So, you’re already out of debt and already save and invest as you see fit?

Your home’s in great shape, too?

You’re probably looking for other smart ways to use your tax refund to get ahead in life.

Consider these:

• Invest in passive income sources: With some time and money up front, you can create sources of passive income that generate income, even when you’re asleep. Here are some of my favorite passive income ideas.
• Learn a new skill: Your local community college most likely offers a variety of courses. In most areas, tuition may be low enough for your refund to cover a semester or two. You can learn new software or coding. You can even start something bigger like a career in nursing, teaching, dental hygiene, or hospitality.
• Plant a garden: A vegetable garden in your yard could save you money on groceries and lead to a more healthy lifestyle. You’d need some equipment, some knowledge, and some seeds. Your tax refund could get it up and running this spring.

8. Use Your Refund to Improve Your Life

There’s more to life than making smart money decisions.

If you’re in solid shape financially, you may be ready to simply make your life more enjoyable.

If so, you may like these ideas:

• Exercise: Scientists have proven people who get physical exercise feel better mentally and physically. Using your refund to pay for a gym membership and exercise gear may be just the catalyst you need. You may even be able to hire a personal trainer for a year.
• Cosmetic dentistry: Maybe you never got braces as a kid and you’ve always regretted it. Maybe you need a crown or a bridge and your insurance isn’t as robust as you’d like. Your refund could make it happen.
• Redecorate a room: Your environment at home can also impact your perspective on life. New curtains, new paint, new furniture — they may not add much to your home’s property value but they can add value to your everyday life.
• Bon voyage!: A warm-weather vacation or an Alaskan cruise? Whatever your preference, a refund-financed vacation may be just what you need.
• Learn an art: Music lessons, painting supplies, dance or ice skating lessons, a literature class — following a passion can give life more meaning and enjoyment. Your refund could make it happen this year.

9. Use Your Tax Refund to Help Others

Helping others is contagious. People with money get a genuine thrill from sharing with people who need it:

• Charitable giving: This one’s self-explanatory. Just about every community has nonprofits to help everything from early childhood education to abandoned animals. You can also get a tax break for next year with your donation.
• Religious giving: If you enjoy supporting your faith community financially, your tax refund can help you help more.
• Simply giving: Whether it’s taking your friends out for dinner one at a time or paying the bill anonymously for a party of six across the dining room, giving can be infectious.

Is Your Tax Refund Too Large?

Common sense says there’s no such thing as too much money.

However, common sense isn’t always spot on, especially when the subject is taxation.

Getting a huge refund means the government has been holding on to a lot of your money all year. That’s OK if you enjoy the windfall of a refund every winter or early spring.

But if you’d rather have the freedom to use your own money the way you want all year, you should consider changing your withholdings at work. Your human resources department can help.

For example, you could be investing your income all year and earning interest. Uncle Sam doesn’t pay interest on your money when the IRS holds onto it until refund time.

The opposite can also be true: If the government didn’t withhold enough of your income, you could have a tax bill this year instead of a refund.

How to Optimize Your Tax Refund

Simply put, taxes aren’t simple. Tax rebates and tax credits, along with overpayment or underpayment during the previous calendar year, work together to create your refund or your amount owed.

You can’t change last year’s withholdings at this point, but you may be able to claim more rebates and credits than you thought which can increase your refund.

A tax professional can help you find out. You can also get professional tax help online through platforms like TurboTax and H&R Block.

Rebates and credits will require some documentation.

The American Opportunity Tax Credit, for example, can repay you for your children’s higher education expenses.

New energy-efficient appliances, child care, even money you spent on sales taxes last year — they all can add to your tax refund this year when you file.

So if you want to maximize the power of your refund to make life better this year, first make sure you’re getting as much of your money back as possible.