If you’re lucky enough to be receiving a refund this year one of the smartest financial moves you can make right now is to put yourself on a plan for financial freedom and security. With the average federal refund near $3,000, going on a shopping spree, although enjoyable, would probably be a missed opportunity.
Here’s a short list of smart ways to use your tax refund:
Pay Off Credit Card Debt
If you have credit card debt, paying it off is the best investment you can make with your tax refund. Doing so will actually make you money as you will not have to pay the compounding interest.
When you make a one-time lump sum, if you’re not able to pay off the entire balance, make sure that your one-time payment is applied directly to your principal loan balance (not toward next month’s regular monthly payment).
Start an Emergency Fund
If you don’t have outstanding credit card debt, the next most important step you can take is to put the refund toward ensuring that you have enough saved in an emergency fund.
You never know when an emergency will strike. Whether it’s an unforeseen medical expense, home repair or unemployment, don’t get caught off guard. You can use your tax refund to help start an emergency fund if you don’t already have one or add to an existing emergency fund if you do. Ideally, you should aim to have enough in your emergency fund to cover three months of must-pay living expenses.
If you have taken care of both of these, consider dividing your refund into two pots. The majority of the money should go toward a financial goal or address a financial anxiety. The rest you can spend on something you’ve wanted.
Fund a Roth IRA
Use your tax refund to fund a Roth IRA, which is one of the best ways to invest in your financial future. What is a Roth IRA? A Roth IRA is an individual retirement account that you can fund with after-tax money. You can invest the funds in your Roth IRA just like a regular investment account. Unlike a Traditional IRA, the funds in a Roth IRA grow tax-free since they are taxed upfront.
If you withdraw any funds from your Roth IRA after age 59 1/2, they are yours to keep without paying any taxes. Also, unlike a Traditional IRA, you are not required to make mandatory withdrawals from a Roth IRA at age 70 1/2.
There are limits on who can contribute (and how much you can contribute) to a Roth IRA, so check with your local brokerage firm for details.
Invest in Your Home
If you’re planning on selling or refinancing your home this year, concentrate on projects where you’ll recoup the highest amount of your investment at resale, in addition, it’s important to also keep in mind that not all home improvements are about the bottom line. If a bathroom or kitchen remodel or a new deck would increase your enjoyment of your abode, that’s reason enough to use your tax refund to make needed or wanted upgrades.
Invest in “You”
Investing in yourself is also not a bad idea. You can do this a number of ways. Using your tax refund to pay for additional training, tuition, a work-related conference or membership in a professional organization is an investment that can pay off for years to come in bigger paychecks and greater job stability.
Take a portion of your return and spend on an experience. Invest in travel or music lessons. Studies show that experiential purchases make us happier — and for a longer period of time — than buying material things.
You could also invest in long-term peace of mind for yourself and your family by using your refund to purchase a will or other essential estate planning documents, such as an advance directive and a power of attorney.
And lastly, if you can’t imagine spending money on yourself, give it away. If you are in a position to do so, increase your charitable giving.