How To Spend Your Tax Refund
Posted: July 6, 2021 in Achieving Financial Goals
Your 2020 tax refund could present an opportunity to improve your financial circumstances and help build your financial future. With some thoughtful planning, you can save or invest your refund, pay less on upcoming taxes, or receive a larger refund from your next filing. Before you decide how to spend your refund, think of those funds as your normal income; it’s neither gifted money nor a bonus. You worked for it, and it’s the extra money that went to the IRS that you really didn’t owe. With that in mind, here are some ways you might consider using it.
Start an Emergency Savings Fund
Overall, household spending continues to surge as the cost of food, housing and utilities rise. Nearly 40% of American adults surveyed did not have enough money to pay for an unexpected expense, and only 61% claimed they could cover a $400 emergency.
Depositing your tax refund into an interest-bearing savings account may help you get through an emergency expense. Plus, when using funds from a savings account to help pay for an emergency expense, you can avoid the costly revolving interest that comes with using a credit card.
Pay Off High-Interest Debts
High-interest debt can severely limit your financial options by locking you into monthly payments that provide little room for other spending. It also negatively impacts your credit score when your available credit usage is high. Making payments towards your high-interest debt can help improve your credit score while also reducing the amount of interest you owe.
Paying off credit card debt may come down to a choice between tackling either the card with the highest balance first or starting with the account with the highest interest rate. Spend some time going over your accounts with a calculator in hand to help determine which approach is the best choice.
Open an Investment Account or Start a Retirement Plan
Although the average return on investment can be affected by a range of factors, investment accounts can experience a 10% return each year. If you haven’t done so already, you may wish to learn about the various stocks and portfolios currently available. Launching yourself into the investment world could be a good way to spend your tax refund.
Contributions made to a qualified retirement account provide long-term investment benefits. They could also increase your next tax refund through the Saver's Credit, which was previously called the Retirement Savings Contributions Credit. Consider building your future by investing your tax refund into a 401(k) or other qualified retirement accounts.
Make Charitable Contributions
The hardships caused by the pandemic motivated many individuals to give back to their communities by contributing to charitable organizations serving those in need. In addition to helping others, donations made to qualified nonprofit organizations normally allow tax liability deductions of up to 60% of an adjusted gross income.
The turmoil caused by the pandemic also brought about the CARES Act, which Congress passed in March 2020. The legislation includes a unique opportunity to deduct 100% of your charitable donations made during the year. This provision of the CARES Act has been carried over to reflect donations made during 2021, so donations made from your 2020 refund could become a 100% tax deduction when you file an itemized return for the year 2021.
Shop Around for Something Nice
If you really feel you deserve a splurge item or new gadget to commemorate getting through the year 2020, there’s no real harm in buying something if you can really afford it. Keep in mind, however, that your tax refund is your own hard-earned money coming back to you; it’s not free money by any means. Take your time to search for the most affordable price and “sleep on it” for a few days to see if it has the same amount of draw for you after you consider other uses for your refund.
Sources:
Sources:
Board of Governors of the Federal Reserve System, 2019, www.federalreserve.gov/publications/2019-economic-well-being-of-us-households-in-2018-dealing-with-unexpected-expenses.htm.
“Charitable Contribution Deductions.” Internal Revenue Service, 2020, www.irs.gov/charities-non-profits/charitable-organizations/charitable-contribution-deductions.
McGurran, Brianna. “Should I Pay Off Debt With the Highest Balance or Highest APR First?” Experian, Experian, 7 Feb. 2020, www.experian.com/blogs/ask-experian/should-i-pay-off-highest-balance-or-highest-interest-first/.
“Retirement Savings Contributions Savers Credit: Internal Revenue Service.” Retirement Savings Contributions Savers Credit | Internal Revenue Service, 2020, www.irs.gov/retirement-plans/plan-participant-employee/retirement-savings-contributions-savers-credit.
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