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What You SHOULD Be Doing With Your Tax Refund

by David Carlson
April 7, 2016 | Money

Most U.S. taxpayers receive a refund. In fact, in 2014 nearly 8 out of every 10 U.S. taxpayers received a refund.

The average refund was around $2,800. That sort of one-time cash infusion can be a huge boost for anyone’s finances.

There are plenty of fun things you can do with your tax refund. You can head to Vegas and try your luck at the tables. You can buy that top of the line road bike you've always wanted. And who doesn’t love a brand new MacBook?

You get the picture: spending your tax refund isn’t difficult. Give someone a few grand and I’m sure they’ll have plenty of ideas of what they could do with it.

But tax refunds also offer a great opportunity to make a big financial move. It’s not every day that you get a big lump sum of cash deposited into your bank account.

So as much as you might want to treat yo'self (immediate gratification can be so nice), here are some smart things you can do with your tax refund.

Tax Refund

1) Start or add to an emergency fund

Most people do not have emergency funds. MarketWatch recently reported “approximately 62% of Americans have no emergency savings for things such as a $1,000 emergency room visit or a $500 car repair, according to a new survey of 1,000 adults by personal finance website” What's more, only 33% of millennials report having enough to cover unexpected expenses.

It can make sense to put your tax refund towards an emergency fund even if you have credit card debt. Personal finance expert Dave Ramsey recommends a $1,000 emergency fund while paying down debt, but many have argued that this is far too low.

Putting your full tax refund towards establishing an emergency fund will not only help avoid taking on debt when the next emergency arises, it will also give peace of mind knowing that funds are set aside if needed.

Even if you already have an emergency fund it never hurts to bolster it further. It’s not easy to build up the often-recommended three to six month of expenses in an emergency fund, but a tax refund offers a unique opportunity to build your emergency fund further.

Tax Refund

2) Invest it

As Forbes recently reported, 68% of Americans aren’t contributing to an employer-sponsored retirement plan. No, these statistics are not skewed by children and retirees, as this statistic is made up of those who fall in the 25 to 64 age group.

Saving for retirement is important at any age, but it’s not always easy. Many live paycheck-to-paycheck or at minimum, feel financial strain. It’s tough to justify stashing money away in a fund you won’t access for decades when you could use the money now. But when compound interest is factored in, it can be a huge missed opportunity to not put something into a retirement account today.

If you haven’t been contributing to a 401k or IRA, consider putting some or all of your tax refund towards an IRA. If you put it towards a traditional IRA you will also be saving money on taxes next year since traditional IRAs are pre-tax. You can contribute up to $5,500 towards an IRA in 2016.

Tax Refund

3) Pay down debt

Paying down debt is almost always a good idea. Paying down high interest credit card debt in particular can be a great use of your tax refund.

Holly, a personal finance expert who owns the website Club Thrifty and writes about personal finance for a number of websites, says, “For an instant return on your money, use your tax refund to pay down high interest debt. Not only can you unburden yourself from any loans you can pay off, but you'll save tons of money on interest in the process.”

If your tax refund doesn’t cover all your high interest credit card debt, consider looking into zero percent balance transfer cards. If you transfer your debt to these cards you are given a grace period such as six or nine months where you will pay no interest on your debt. This provides short-term interest relief and allows you to focus on paying down the balance of your debt.

Credit card debt isn’t the only debt, though. With over $1.3 trillion in student loan debt outstanding in the United States, there are many people who would benefit from throwing their tax refund towards their student loan debt.

Tax Refund

4) Save it for future medical costs

Have kids or plan on having kids one day? Sophia Bera, founder of Gen Y Planning, recommends putting away money today for prenatal care and your children’s future medical costs. “Find out if your HDHP is eligible for a Health Savings Account (HSA). Start building up your HSA now, to use for health care costs in the future.”

Even if you don’t have kids and you're the epitome of health, setting aside money for future medical costs is a wise decision. If you have an HSA it’s hard to argue against not putting money into it.

HSAs offer a unique opportunity as you can contribute up to $3,350 as an individual or $6,750 as a family in 2016, tax-free. If you use these funds for qualified medical expenses you can withdraw funds tax-free as well. If you hit an account balance above a certain threshold, such as $2,000, you can invest the additional balance.

There are two more huge benefits to an HSA that make them a no-brainer for contributing to with your tax refund or otherwise. First, they never expire. That means you can use the funds (tax-free) later in life when you are likely to have a high amount of medical costs. Second, they are treated similar to a traditional IRA in retirement. You can withdraw the funds in retirement and they will be treated as regular income.

Tax Refund

5) Save for your children’s college education

We’ve all heard about the rising cost of college tuition---there's a decent chance you have experienced it firsthand---but there hasn’t been much progress made on solving the problem. Even if progress is made over the next 10 or 20 years, it’s safe to assume that your children’s college education will be very expensive.

While it may be unrealistic to save enough money to pay for your children’s education, setting aside even a little money today will greatly benefit them when they do go to college. There are an unlimited number of demands on your finances, so it’s easy to put saving for your children’s college education at the bottom of the list. A tax refund is a good opportunity to contribute to make it a priority.

The best way to save for your children’s college education isn’t to simply put money into a saving’s fund. Instead, look into 529 plans. 529 plans are college savings plans that are exempt from federal taxes. There are different plans for different states, so it’s best to do research first. Check out U.S. News & World Report’s guide or GoodCall's Comprehensive Guide to 529 College Savings Plans to start.

David Carlson
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