3 in 4 Americans receive an annual tax refund from the IRS.
Last year, the average check cut by the IRS was $2,873.
If you’re like many Americans, your tax refund is the largest cash infusion you’ll receive all year.
While the tax refunds are smaller this year for several reasons, they’re coming at an opportune time. Inflation increased almost 8 percent compared to last year, and with household savings drying up, cash-strapped consumers are taking on more credit card debt to finance purchases.
It’s easy to feel like your tax refund is free money, and you may be tempted to take a vacation or go on a shopping spree right away.
A refund, however, is not found money. You earned the refund with every passing paycheck, and you should utilize it carefully. This could go a long way in helping to improve your overall financial health.
How you should spend your tax refund largely depends on your unique circumstances. Still, there are a handful of uses of the money that could make sense this year.
1. Build or Boost Your Emergency Savings
If the pandemic taught us anything, it’s the importance of having a well-funded emergency fund.
An emergency fund is an essential financial tool that can help you in case of a salary decrease, sudden job loss, flooded basement, medical emergency, and any event that requires instant access to larger sums of money.
Achieving financial security involves planning for such unexpected events. Your emergency fund should contain 3-6 months’ worth of living expenses, which is the amount you spend on stuff like rent, utilities, gas, groceries, and other essentials.
According to a recent Bankrate survey, 56% of Americans cannot manage to pay an unexpected $1,000 expense from a savings account. If you’re in this category, a surprise expense like a dentist visit or a major car repair could derail your budget and get you further into debt.
Putting your refund into a money market or high-yield savings account that you can access quickly could leave you breathing easier should one of those unforeseen events arise.
You would have not only a rainy-day fund to fall back on but also better interest on your money.
2. Invest in the Stock market
A tax refund is a big windfall. With that in mind, investing some or all of it could jumpstart your planning for the future. Investing is a proven way to build wealth that lasts.
When it comes to investing, you have many options. However, the stock market has historically delivered greater ROI than treasury bonds, CDS, or savings accounts.
While the fluctuations in the stock market make it a risky choice for the money you’ll likely need in the short-term, the long-term outlook makes investing in the stock market a better option if you don’t have an immediate financial need. You will have plenty of time to overcome any dips in stock market performances while also experiencing any gains during that period.
You can either pick individual stocks or choose an index fund that moves up and down along with the market.
3. Contribute to a Retirement Plan
Most financial experts say you need approximately 80 percent of your pre-retirement income to support the same lifestyle after you retire.
That means if you make $50,000 annually at retirement, you need at least $40,000 per year to live a comfortable lifestyle after leaving the workforce.
For most of us, those are big numbers. But 401(k) and IRA contributions can help you boost your retirement balance. These retirement savings vehicles are an excellent option as they allow your money to grow, thanks to compound interest.
What better way to build your retirement nest egg than by using money that isn’t a part of your paycheck anyway? You can use your tax refund to purchase or augment your retirement plan.
Consider maxing it out too. The contribution limits for traditional and Roth IRAs in 2022 are $6,000 or $7,000 for those 50 and older. You can contribute up to $20,500 to a 401(k) and an extra catch-up contribution of $6,500 If you’re over 50.
When retirement comes knocking, you will be grateful that you had the foresight to save for it rather than splurge it on something you’d have long since forgotten about.
4. Prepare for Restart of Student Loan Payments
Student loan payments can be a frustrating expense, one that can hold you back from accomplishing other financial goals.
Thanks to the pandemic-era relief on student loan payments by the government, many Americans have gone two years without paying those bills.
But things will soon change with student loan payments slated to resume in August. If you’re not financially prepared, this change might be rocky for you.
Instead of having a sudden change in your budget, you can use part of the refund to provide a cushion for the recommencing of repayment. This will help you ease into it.
The average student loan bill was approximately $400 before the government’s pay pause. Since the accumulation of interest on most federal student loans was suspended during the relief period, expect your monthly bill to be the same as it was before the pandemic.
Making a larger-than-usual payment can cover payments for a few months before you’d have to rearrange your budget.
5. Pay Off Some Debt
Whether it’s personal loans, student loans, or auto loans, living with debt can be all-consuming.
If you have high-interest loans, it may make sense to dedicate some of the tax refund to paying them down.
Credit card debt is the most common and worst kind of debt in America with interest compounding against you month after month. According to Experian, the average balance on credit cards in 2021 was $5,525.
While your tax refund may not be significant enough to wipe your balance clean, you can use it to pay down the debt with the highest interest rate. It may not be the most fun thing to do with a tax refund, but doing this will help you save money down the road in interest charges.
Once you’re debt-free, start using your money for yourself instead of contributing to the bank’s profits by paying credit card interest repayments.
When you receive your tax refund, consider using all or a portion of it to enhance your finances.
As you can see, there are many different ways you can use your tax refund wisely. Check out our tax prep checklist here.
Read our article on mid year tax check up and 5 steps you can take now.
If you’re having trouble paying down debt during this tax season, Americor can help. We offer debt relief solutions for credit cards and unsecured debt.
Contact us today to receive a free debt analysis and speak to a certified debt consultant.
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