Tax day comes a little late this year: April 18. This is because the 15th falls on the weekend and Monday is Emancipation Day, a holiday in the District of Columbia. However, if you’re expecting a refund this year, hopefully you’ve already filed and your money is on the way.
The IRS expects about 70% of taxpayers to get refunds this year, and the average refund last year was $2,860. This is a significant amount of money for most taxpayers and an opportunity to make a real difference to your financial health. You can spend that money on something that will make you feel rich now — or do something with it that might actually help you become rich someday (or at least more secure). Here are some ideas:
1. Pay off your credit cards. If you have high-interest credit card debt, using your refund to pay it down can save you lots of money. The average variable interest rate on credit card balances is over 16%. Think of paying your credit card debt down as a risk-free investment that pays you the rate your credit card charges.
2. Pay down your other debts. You can also put this money against your student loans, car payment or even a mortgage. Just check to be sure your loan servicer will actually use this payment to reduce the loan principal, rather than count it as a future payment. Reducing principal will help you pay off the loan faster and potentially save you thousands in interest.
3. Start saving for retirement. If your employer matches your 401(k) contributions, but you’re not contributing because you feel you can’t afford it — here’s your chance. Employer matching contributions are free money, and you should put it to work for your future. Since 401(k) contributions come from payroll deductions, you usually can’t just contribute your refund. Instead, find out how much your firm will match and divide it by the number of pay periods left in the year. Have your payroll department contribute that amount from your paycheck each period. Put your refund in a savings account at the same bank as your checking account, and move money into your checking account if you need it to pay your bills.
There are two big benefits to doing this. First, the earlier you start saving for retirement, the longer your money has to grow. Your 65-year-old self will thank you for starting young! Second, contributing to your 401(k) will reduce your taxable income and might give you a bigger tax refund next year.
4. Establish an emergency fund. Even if you’re already maxing out your 401(k), consider putting your refund in an FDIC insured savings account. According to a recent survey, 69% of Americans have less than $1,000 in savings. They can’t afford a brake job, let alone a broken leg. You should therefore aim to build up a nest egg that will last you three to six months. It might take some time to build up to that, but your tax refund can get you started. Interest rates are very low today, but at least half should be in a savings account or money market fund, and the rest can be in something low risk that can be sold quickly, like a short-term government bond mutual fund or ETF.
5. Invest in your career. Since the recession, thousands of workers have stopped looking for a job, often because their skills have become obsolete. Many fields are changing so rapidly that it is easy to be left behind. Your skill set is your most valuable asset, and it’s important to refresh it with continuing education, industry networking, professional certificate programs or even broadening your horizons into a new field. Investing some of your tax refund in things that could increase your income is a smart move.
Finally, if you get a big refund, check with a tax professional to adjust your withholding or estimated tax payments. A big refund feels good, but it means you are lending money to the government at 0% interest. You could be saving, investing or paying down debt with this money. A tax pro can help you keep your money working without underpaying this year’s taxes.
John Foley, CFP® is an investment advisor at SoFi Wealth, LLC.