Each year, the average American family receives a tax refund of about $3,000. Remember that’s just an average. Some people will receive more and others less.
If you’re one of those lucky people receiving a large amount back you might find yourself thinking, “What’s the best way to spend my tax refund?”
It’s important to make a wise choice here, because you have an opportunity to significantly improve your finances by making some smart money moves.
You can start by reconsidering your tax withholding and filing a new W4 form so less money comes out of each paycheck you receive throughout the year.
You won’t get as big of a tax refund next year but you will have more money in your paycheck which will really help your monthly budget. After all, that’s YOUR money and all you’re doing is loaning it to the government interest free.
Now let’s talk about some other smart things you can do to make the most out of your tax refund.
Pad Your Emergency Fund
The furnace dies on the coldest day of the year. Your daughter falls off the monkey bars and breaks her arm. Your dog eats an entire chocolate cake (including the plastic cake carrier it was stored in).
Unexpected expenses like these happen to everyone at some point and if you’re not prepared you’re likely to go into credit card debt trying to pay for them all.
Of course, the time to prepare for an emergency is before it happens. Consider using your tax refund to start or pad your emergency fund to cover unexpected expenses that are bound to happen sooner or later.
You’ll want to keep your emergency funds somewhere liquid like a high yield savings account. This way you’ll be able to access it easily in an emergency while also earning a little interest.
Pay Down Debt
If you have high interest credit card debt, one of the best moves you can make is to pay that debt down.
Just think about it…if you’re being charged 19 percent interest on a credit card and you pay it off that’s like earning a 19 percent return on your money. You’d have a hard time matching that kind of return anywhere else!
If you’re buried in debt and struggling to get out, this is probably the way to spend your tax refund.
Open a Roth IRA
If you’ve been meaning to start investing but can never seem to find money to invest, now is your chance.
Take your tax return and open up a Roth IRA with a discount broker or a mutual fund company. Vanguard and Fidelity are both popular options that offer low-cost index funds which are perfect for the average investor.
You can also invest a in wide variety of stocks, bonds, and mutual funds through a Roth IRA.
The beauty of a Roth IRA is that you put in after-tax funds and if you follow the rules all of your earnings can be withdrawn tax free when you retire.
Start an Investment Account
If you don’t qualify for a Roth or if you prefer the more hands on approach, you can still open up an investment account with an online broker.
Pour your money into stocks, mutual funds, ETFs and more so you can start building wealth and increasing your net worth. Personally, I’m a fan of stocks that pay dividends because they serve as an additional income stream. If you’re still a bit hesitant, you can buy fractional shares first then buy the full share if you find it worthy.
Make a Principal-Only Mortgage Payment
Your mortgage is likely the largest amount of debt you have.
The interest rate should be pretty low, so it makes more sense to pay down high interest credit card debt first.
But if you have no other debt and you’re already investing for retirement, you can make an extra mortgage payment and have it applied entirely to principal.
Get in the habit of doing that every year and you could pay off your mortgage years earlier than the typical 30 year term while saving tens of thousands of dollars in interest charges.
I’m a big believer in lifetime learning and I’m always looking to learn a new skill. You can learn a lot for free just by reading if you take advantage of the internet and your local library.
But there are times when free materials aren’t enough and you need to take a class or two.
You can learn something just for fun (learning to speak Italian is on my to do list) or concentrate your efforts on learning something that will increase your earning power.
For example, earning new certifications will make you more valuable and your employer may offer you a salary increase each time you complete one.
Or you can learn a new skill that will help you start a side hustle to significantly increase your income. Web development and graphic design skills are always in demand.
Start a College Fund
With tuition costs skyrocketing ever higher, it’s never too early to start a college fund for your little ones. You can receive tax benefits if you stash money away in a 529 college savings plan.
Money from a 529 plan can be used to pay for tuition, books, fees, supplies, and equipment required at any accredited college, university, or vocational school.
Do Something You’ve Been Putting Off
Maybe your roof has a few minor leaks or you have some dental work that you’ve been putting off because you never have the extra money put aside to do it.
Now is the perfect time to take care of these types of things while you have the money in hand.
Build a Sustainable Backyard Garden
It never ceases to amaze me how much food my family of five goes through, and my kids are still little. Our monthly food budget is huge and the kids only eat more as they get bigger.
Our house has a nice corner that gets tons of sun so a few years ago we built a little garden back there to grow some fruits and vegetables. We grow tons of delicious tomatoes, peppers, lettuce, basil, and more.
There’s nothing fresher and more delicious than growing your own fruit and veggies and it can also save you a ton of money.
Create a Memory
Studies show that people enjoy more enduring happiness from their experiences than their possessions.
Splurging on a new flat screen TV might make you feel good for a little while but that happiness will fade rather quickly as you see newer models with screens that are bigger and clearer than your own.
On the other hand, experiences become a part of you.
I still remember driving up to Niagara Falls with my then girlfriend (now wife of 17 years) for our first vacation together. We took a day trip into Toronto and I enjoyed one of the most delicious burgers ever at a restaurant across the street from the Hockey Hall of Fame.
This past summer we relived that memory, this time with the kids along for the ride. The whole family had a awesome time and that’s something that will stay with us all forever.
I also think back to our honeymoon in Aruba and I’m glad we were able to see and walk along the natural bridge before it collapsed. That is an experience I’ll never forget and I can’t put a price on it.
While many personal finance bloggers would be shocked and dismayed at the thought of actually spending your money on something fun, I prefer a more balanced approach.
We can’t just hoard all of our money and not have a little fun with it (within reason).
So if you have some extra money and you want to create an experience to share with your family for years to come, I say go for it.
Help Someone in Need
As you stand pondering the best way to spend your tax refund, take a moment to think of people less fortunate than yourself. There are a lot of people struggling in this world and even a small contribution can do a lot of good.