It’s that time of year again when college students and side hustlers get paid to swing around signs while wearing costumes to make themselves look like the Statue of Liberty to convince you to file your taxes with a certain company.
No one likes to file taxes, but it is nice when you qualify for a tax refund (and those sign swingers can be pretty entertaining, at least). The average tax refund received for 2015 was $3,120, according to the IRS, for a grand total redistribution of $125 billion to the American population last year.
Unless you have a plan for when you receive a check of that size, it can be pretty easy to squander that money away. To prevent waste, here are 5 ways to make the most of your tax refund.
1. Convert Your Tax Refund Into Your Emergency Fund
Most financial planners advise their clients to build an emergency fund of more than or, at least, equal to a full three to six months’ worth of living expenses. This includes money for the mortgage or rent, groceries, gas, insurance payments, and other daily living expenses.
Unfortunately, a staggering 25 percent of Americans have nothing saved at all. An emergency fund will help you make it if you experience a personal, medical, or financial catastrophe. So, while it may be tempting to use that three grand as a down payment on a new car, you will be much better off in the long run if you use that money to create a financial cushion in the event of being laid off from your job, not being able to work because of medical reasons, or if something catastrophic happens, like losing your home to a fire or a flood. Three grand isn’t three to six months’ worth of expenses, but it’s a great start.
2. Chip Away at Debt
As important as it is to have an emergency fund, it’s important to try to live debt free as well. If you have mounting credit card payments or other bills, your tax refund can serve as a huge relief from some of your financial burdens. Decide whether to use your refund to pay off a smaller debt completely or use the money to chip away at a larger debt or debt with a high interest rate.
If for example, you still owe $2000 on a vehicle, you could use your refund to pay off that full amount. Then, since you have freed up $200-$300 a month in car payments, you can then use that money to pay towards a credit card or student loans instead. This is a good example of how the debt snowball works.
There is no one solution for how to best pay off debt. Look at your personal situation and evaluate how your tax refund can help you to put your best financial foot forward.
3. Save Part of Your Tax Refund For Everyday Use
Building an emergency fund and/or chipping away at debt should be your number one goals. But it is perfectly acceptable to save some of that money for daily use, especially if you have been strapped for cash. A good way to use your refund is to save twenty to thirty percent of your refund into your checking account. Having enough money for gas, groceries, your kids’ activity fees, and other unexpected expenses (like doctor copays, etc.) can help prevent you from having to add even more money to your credit card debt.
4. Invest and Make it Grow
Already have savings and don’t have any debt? That’s great! A tax refund can be a perfect way to add more fuel to your financial fire by investing. Consider contributing some or all of your refund into your retirement savings account, such as a Roth IRA, or into your child’s 529 College Savings Account or Coverdell savings account. You can never have too much stashed away for the future.
5. Use a Little Bit for Something Fun
Even if you do have debt, no savings, and nothing saved for retirement it’s OK to spend a small portion of that refund on yourself. Whether it’s treating your significant other to a nice evening out or buying something (inexpensive) that you’ve had your eye one, using your money for something fun will help you keep yourself on track for the next year. It’s like trying to lose weight by going on a strict diet. Eventually, you’re going to crack under the pressure and just indulge in the things you’ve been holding off from anyway.
So, don’t feel bad for wanting to buy that part for your car, getting a manicure, adding to your tattoo, or buying tickets to a concert. Whatever it is you decide to indulge on, you’ll be fine, as long as you’re spending the majority of your refund with a wise and well-thought-out financial plan in mind. (Just don’t go too crazy and spend it all on frivolous choices.)
Stay on Top of Your Finances
If you’re struggling to make ends meet throughout the year, a tax refund can help serve as a great buffer for your finances, but don’t feel like you have to rely on that refund to make ends meet every year. There are some great, free financial tools available to help you keep on top of your finances. Personal Capital’s website and mobile app can help keep you accountable and offer great budgeting and tracking resources. SunTrust also offers a free resource at Onup.com that gives you tools for budgeting and creating a financial plan for free.
Until next year, however, if you have already filed your taxes, and you’re wondering, “Where’s my refund?” remember that you can go to the IRS website to check the status of your refund. They update all refund statuses every 24 hours after you file electronically or four weeks after mailing in a paper return.
How do you like to spend your tax refund? Saving, debt payoff, investing, or personal purchases?