If you’ve received a tax refund from Uncle Sam this year, don’t be celebrating just yet. Aside from the fact that it was your money initially (not a kind gift from the government), you may need to make some adjustments before the next tax season starts.
If you’ve withheld too much from your paycheck, you’re basically lending your money to the government for free. What’s worse is that you lose on time that your money could grow for you. If so, you’ll need to adjust your federal income withholding tax or revisit your W-4. That’s not to say you don’t feel good about a government lump sum. With that said, don’t be caught treating your refund differently than your paycheck. Your money is valuable and just like your paycheck, every dollar of your refund should be assigned a purpose.
In 2020, the average tax refund payment was more than $ 3,125, according to the IRS. If you’re one of those people who got a tax refund this year before wasting your tax refund on a vacation or other big ticket item, there are a few ways you should first consider a few ways you can make that money work for you.
Here are some suggestions on how to deal with your tax refund:
1. Contribute to your emergency fund
Have you thought about what would happen if you were unexpectedly fired from your job or faced with huge unexpected costs? If you are not prepared for this or a host of other calamities, consider holding on to your tax refund.
It is recommended to use easily accessible cash for “rainy days” for at least a few months. Though some financial experts have said that six months to a year of emergency money is necessary. However, how much you save for an emergency largely depends on your situation.
Read our complete guide to emergency funds here.
2. Pay off your debt
Possibly worse than an unexpected emergency is today’s emergency, also known as debt.
If you are one of the many Americans facing high interest debt, your focus should be on cutting costs and pouring every free dollar into your debt. Additionally, it is often recommended that you pay off your debts before setting up an emergency fund (we disagree, but you should still not avoid paying off your debts).
The logic behind this is that if you are already in debt and you run out of your emergency fund, you will not have the financial means to borrow money. Borrowing money on credit cards is never an attractive option, but it can be necessary in dire circumstances.
If you have student loan debt, this may not be the best time to repay it (due to all Covid-19 student loan programs). Instead, focus on other debts like credit cards or car debt.
3. Save more for retirement and other goals
If your finance house is in good shape and you’ve built a healthy emergency fund and are debt free, another option to consider for your tax refund is to invest it.
The average American doesn’t spend enough money on retirement. Many financial advisors recommend investing 10% to 15% of your annual income in retirement. However, with the time value of money, the sooner you invest, the better it is of course.
If you start investing late, it’s never too late to fill that void. A tax refund of $ 3,125 will surely help you get closer to your goals. In fact, that amount would be half of what you can contribute to your IRA this year.
4. Refinance your mortgage or do some home improvement
Mortgage rates are at rock bottom at all times. When you are financially prepared and ready to buy, there really is no better time to buy. If you already own a home, you can take advantage of these interest rates by refinancing and paying your closing costs and fees with your refund. You can save money immediately on interest payments.
If you are really ambitious, you can keep paying the same monthly mortgage amount and cutting the principal amount you owe. If there’s a high dollar project you’ve been postponing, now may be the perfect time to get it off your list. Home improvement projects are a great way to add value to your home, and usually the benefits are immediate.
Connected: Best Places To Refinance Your Mortgage Online
5. Invest in a taxable account
If you’ve already run to the full with your tax-protected accounts, you are definitely ahead of the pack and you probably don’t need to hear this advice. Opening a brokerage account can be a great way to further diversify your portfolio and grow your money for you.
Since these investments are fully taxable, it can be a good idea to go for low-cost investments or tax-efficient mutual funds or ETFs.
6. Giving to charity
Depending on who you are, this might be number one on your list. For others on a tight budget, it can be difficult to donate to charity. A tax refund is an opportunity to contribute to a charity of your choice.
Charitable donations may not return in the form of dividends or capital gains, but sometimes the benefits a donation can bring are more valuable than anything money could buy. Not to mention, you can deduct charitable contributions from your taxes.
7. Start your own business
If you’ve got a business idea that you’ve been postponing, a refund might just be what you need to get things started. This is a great way to see the return on your investment, and tax deductions can be made for your small business too.
If you don’t know where to start, we have a list of the 15 best online business ideas to start at home right now.
Bonus: Change your withholdings to not receive a refund
One option that you may not think about is to simply change your tax withholding from your paycheck so that you don’t get a refund – you owe something. This may seem crazy, but remember, a tax refund is just a refund from Extra money You’ve been paying the IRS all year round. It is your money!
If you change your W4 withholdings on your paycheck, you’ll get bigger paychecks year round. Then at tax time you would pay any difference you owe. This is something most savvy investors and high net worth individuals do. Never let the IRS receive any extra money that is yours.
The only downside here: you have to plan on writing a check to the IRS in April. If you don’t save or have the money, you could get into trouble. Before adjusting your withholdings, make sure you have a plan.
Regardless of how much of a refund you get, a tax refund, if any, should be as valuable as any other dollar you’ve made. If nothing else, it should be treated with added valueas you are basically paid for the work you have done all year round.
Whether or not your refund was expected, it should be used in the way that is most beneficial to you in life. As tempting as it is to indulge in something you want, as well as all of your hard-earned dollars. Investing in something that will help you achieve your goals is far greater than any product that could be purchased at a mall.
What other investment ideas do you have for your tax refund?