Ready to use your tax refund to splurge on a lavish vacation or a new wardrobe?
You may want to reconsider!
Some taxpayers rejoice at the anticipation of early Spring when they can get a few hundred dollars (or even a couple of thousands of dollars) back from the IRS. According to Simply Money Advisors’ research, the average tax refund was $2,895 in 2016.
But if you’re thinking of using the entire amount for your enjoyment, it’s time to look at some other options before you make a financial mistake.
Make a plan: Before you even get your refund, determine where you want the money to go. This will help you think about your financial decisions before you make them. If you decide after you have the money in your bank account, you may make an emotional decision instead of spending it wisely.
Take some time to consider where this money would get the most use. Keep in mind, your refund could get you one step closer to your financial goals.
Boost your emergency fund: If you don't have a little financial cushion, an emergency fund may be a great place to start. Even if you start with $500, this could save you from getting into a bind. You never know when you’re going to need brakes on your car or fix water damage in your house.
Not only will an emergency fund give you a financial cushion, but it will give you peace of mind. Knowing that you have extra cash in case something happens can make you feel more secure. Maybe you can even rest better at night.
Prioritize health care expenses: Have you been putting off that visit to the dentist or screenings at you doctor's office? Many Americans delay health care treatment because of the financial burden. If you need medical care, your tax refund can help fund this expense.
Putting medical expenses on credit can cost you a lot of money in interest if you don't pay it off right away, so using your tax refund may be a more financially responsible way to go.
Negotiate debt: If you have debt in collections, you shouldn't assume you need to pay the entire amount. Try calling your credit card company to negotiate the amount you need to pay. Your tax refund can help you get ahead with your debt repayment.
Of course, you want to determine what your interest rate is on your debt. It may be more beneficial to pay off a portion of your debt and put some of your tax refund toward your retirement savings.
Contribute toward your retirement: If you haven't maxed out your Roth IRA, traditional IRA, Roth 401(k) or traditional 401(k) contributions this year, your tax refund can be a great way to boost your retirement savings.
If you’re younger than 50, you can contribute $5,500 total to a Roth IRA and traditional IRA this year (note: there are income eligibility requirements for contributing to a Roth IRA). If you’re older than 50 you can contribute an additional $1,000. This is called a “catch-up contribution.”
You can also contribute a total of $18,500 this year to your traditional 401(k) and Roth 401(k), combined (if you’re older than 50, you can contribute an extra $6,000).
If you contribute the average tax refund amount ($2,900) every year for 20 years toward a retirement account, you would have close to $120,000 (assuming a 7% annual return and before fees and taxes).
The Simply Money Point
Before spending your entire tax refund, get a plan for the cash. Even better, sit down with your financial planner. He or she can help you determine the best way to have your money work for you.
And to learn more about lowering your taxes now and in retirement, download our free Simply Money Advisors guide.