What To Do with Your Tax Refund – How to Make the Most of Your Extra Cash

If you’re expecting a tax refund, you obviously want to get it as quickly as possible. That way, you can put it to work for you sooner rather than later. The fastest and safest way to get your tax refund is to submit your return online, using e-file.

There are three ways to file your tax return electronically:

1. Use your own tax software. Most tax programs, such as TurboTax and H&R Block, include the option to submit your return by e-file.
2. Use a tax preparer. You can find an authorized e-file tax professional by clicking through a link on the IRS home page at irs.gov and entering your zip code.
3. Use “Free File” on the IRS website. You’ll find it at irs.gov/freefile.
4. Bonus method: Military members have several methods for filing their taxes free.

If you e-file and request a direct deposit, you’ll probably receive your funds in less than ten days. But if you submit a paper return and request a direct deposit or a paper check it could take several weeks longer. Plus you run the risk that your tax form(s) or refund check could get lost or stolen. If you don’t receive your refund, it’s important that you make an inquiry about it using the IRS Refund Status Tool.

What To Do With Your Tax Refund

The average tax refund received for 2020 was $3,125, according to the IRS, for a grand total redistribution of over $100 billion to the American population.

Unless you have a plan for when you receive a check of that size, it can be pretty easy to squander that money away. Once you receive your refund, there are a gazillion things you can do with it. Taking a vacation or going on a shopping spree may immediately come to mind. But I bet you won’t be surprised if I tell you that the best thing you can do with the money is to save it or put it to another use. It might not be as much fun as many other options, but it will certainly go a long way toward improving your personal finances.

Here are my recommendations for what to do with your tax refund in the order of priority:

1. Convert Your Tax Refund Into Your Emergency Fund

One of the most important defenses you have against unexpected expenses or the loss of income is a cushy 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 goal. 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, prescriptions, 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. You can never have too much stashed away for the future.

Consider contributing some or all of your refund into your retirement savings account, such as a Roth IRA. You can contribute up to $5,500 to an IRA in 2018, or $6,500 if you’re age 50 or older. Be aware that there are tax penalties for withdrawing money from a retirement account before the age of 59½. So be sure to put money in an IRA only after you’ve established an emergency fund and are sure you won’t immediately need the money.

If you have children, you may also consider contributing some money toward your child’s 529 College Savings Account or Coverdell savings account.

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 some of your tax 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 on, 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.)

Determine Where to Send Your Tax Refund

You can even opt to split up your refund and have it automatically deposited into multiple financial accounts, like an IRA and a savings account, using IRS Form 8888. If you just want to have the money sent to one account, simply use the direct deposit line that’s on the regular tax form.

Adjust Withholdings if Your Refund is Too Big

An important tip is that if you consistently get big tax refunds each year, you probably need to adjust your withholding so less tax will be deducted from your paychecks. Use the IRS Withholding Calculator to help you complete a new Form W-4 and submit it to your employer (military members can do this on myPay).

Remember that it’s generally not a good idea to use a tax return as a forced savings plan—it’s better to pay yourself first with higher paychecks throughout the year. That way you can save the amount you’d otherwise be paying to the government and make interest on it, instead of loaning it to Uncle Sam for free.

• Related: How much is the ideal tax refund?

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. For example, Personal Capital’s website and mobile app can help keep you accountable and offer great budgeting and tracking resources.

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?