Tax season is always bittersweet. You dread collecting all of your tax forms and going through the actual labor of preparing your tax return. But it often ends with a tax refund, which is something to get excited about.
I remember how excited I was to get my tax refunds in my early twenties. But looking back, I couldn’t tell you a single thing I did with that money. My guess is that I squandered most of it on unplanned and unneeded expenses.
In retrospect, I really wish I’d used that money more wisely, perhaps to pay off debt or fund one of my big goals.
In this article, I’m sharing 12 ways to use your tax return wisely, as well as three things to avoid doing with that money.
12 Things to Do With Your Tax Return
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1. Build your emergency fund
If you don’t currently have an emergency fund, building one should be your first priority when you get a tax return.
People often underestimate just how important an emergency fund is. Almost 25% of Americans have no emergency savings at all, and only 41% of Americans would be able to cover a $1,000 emergency with savings.
Unfortunately, these expenses come up. You never know when your car will break down or you’ll have an unexpected medical bill. And without an emergency fund, people usually have to resort to debt.
The pandemic also showed us just how important an emergency fund is. Millions of Americans lost their jobs, without savings to fall back on.
Not sure how much to save? I generally recommend saving at least one month of expenses while paying off debt and at least 3-6 months of expenses once you’re debt free.
Read: How to Build an Emergency Fund & How Much to Save
2. Pay off debt
Paying off debt can feel impossible at times. You make your monthly payments, but somehow never seem to make any progress.
Extra income injections like tax returns are an excellent way to pay down your debt faster. If you have high-interest debt like credit cards or personal loans, that’s a great place to start. If you don’t have high-interest debt, you can put your tax return toward student loans, a car loan, or your mortgage.
Depending on how big your tax return is, you might be able to make a big dent in your balance. And even if it’s just a small amount, it’ll reduce the amount you pay in interest over the long-run and help you become debt free more quickly.
Read: Debt Snowball vs. Debt Avalanche: Which Debt Payoff Strategy is Right for You?
3. Fund a financial goal
Your tax return can be a great way to pay for a financial goal you’ve been dreaming of, like a big vacation or home renovations.
Your tax return can help you reach your goals even faster. And if you don’t have much wiggle room in your budget, your tax return might be just what you need to reach that goal that didn’t seem possible.
Read: The Best Money Goals to Set in 2021
4. Get one month ahead in your budget
Most people spend their money as (or even before) they earn it. For example, many people struggle to balance the timing of their bills with their paychecks to make sure they have enough in their bank account. Others use their credit card for everything and then pay it off the next time they get paid.
While this might work for some people, it often means spending money you don’t have. Plus, you’re living paycheck to paycheck, and a single late paycheck could result in having to pay your bills late.
The best solution to this is to get one month ahead in your budget. So instead of using your paycheck for this month to pay this month’s bills, you’ll actually use it to pay next month’s bills.
Here’s a full guide to help you get one month ahead on your budget.
5. Start a business
Starting a business was one of the best decisions I’ve ever made. It provided extra income while I was working at my government job. And ultimately, I made enough money to quit my job and run my business full time.
I was pretty lucky in that my business required almost no start-up costs. I paid for the cost of a website domain and a few other small things, and I was ready to go.
But looking back, there’s a lot more I could have done in terms of education and coaching. And many people start businesses that require more start-up costs.
If you’ve been thinking about starting a business, commit to using your tax return this year to get it up and running. You won’t regret it!
6. Advance your career
There are so many opportunities today to advance your career through continuing education, training, or additional certifications. Unfortunately, those things cost money and many employers can’t foot the bill.
If you’re getting a tax return this year and don’t have other plans for it, consider what steps you could take to further your career or help you get the credentials you need to change careers.
7. Fund an HSA
Healthcare costs have been increasing steadily over the years, and many families just can’t cover them.
Unfortunately, medical bills have become the primary reason for bankruptcies. And it’s not just people without health insurance. High deductibles and poor coverage mean that many people with health insurance still end up with huge out-of-pocket costs.
Luckily, there’s a great option to help you save for future medical expenses.
A health saving account (HSA) is available to anyone with a high-deductible health plan. It has triple tax advantages. First, contributions are tax-deductible. Next, you can invest the money and it grows tax-free. Finally, you can spend the money tax-free on qualified medical expenses.
If you have a high-deductible health plan, I highly recommend opening an HSA!
8. Donate to a charity
One of the great things about tax returns is that it’s often money you forget you have coming. You aren’t counting on it to pay any bills, meaning it’s just a bonus.
If you aren’t relying on your tax returns to help pay your bills, build an emergency fund, or pay off debt, I encourage you to consider donating at least part of it to charity.
There are so many people struggling in our communities, and it’s only become worse since the pandemic began. Chances are there are many people in your area struggling to pay their rent or buy groceries.
There are a lot of great organizations out there helping people to make ends meet and keep food on the table. And let’s not forget the organizations helping save animals, research prevalent diseases, and fight climate change. Whatever it is you’re passionate about, there’s an organization working on it that could use your help.
9. Contribute to your retirement account
Many people underestimate the importance of saving for retirement. When it’s decades away, it’s hard to see it as an immediate need. But the thing is, your money has more time to grow the earlier you start saving!
If you aren’t currently saving for retirement, consider starting now. And even if you’re already contributing to a 401(k) through your employer, you can set up an individual retirement account to help you save even more.
10. Save for college
College costs have grown like crazy. In 2021, the average student at a four-year in-state public university spends more than $25,000 per year. And if you’ve got small kids at home, costs might be even higher by the time they head off to college.
There are several good options to help to save for your child’s college education. First, a 529 plan is a tax-advantaged account specifically designed to help you save and invest for college. Another option is a custodial account, which parents can open on behalf of their children to save and invest.
11. Invest through a taxable investment account
If you already have a fully-funded emergency fund, have paid off your debt, and contribute regularly to a retirement account, you might consider using your tax return to invest through a taxable brokerage account.
I don’t recommend doing this until you’ve got your financial house in order otherwise and are already on track to hit your retirement goals. But if you can check those boxes, investing can be a great way to grow your wealth and help you to reach other financial goals.
Not sure how to get started? My current favorite investing book is Broke Millennial Takes on Investing by Erin Lowry.
12. Adjust your withholdings
Some people love getting a huge refund every year. They see it as free money they can spend or use to fund their goals.
But here’s the thing — it’s not free money. It’s money you worked hard for that was unnecessarily taken out of your paycheck. Money that could have earned interest in a savings account or that you could have used to cover expenses throughout the year.
Unless you’re dead set on receiving a refund each year, consider adjusting your withholdings to have less money taken out of your checks. Just make sure you have a plan for that money so you aren’t mindlessly spending it throughout the year.
What not to do with your tax return
1. Use it to go further into debt
Here’s an all-too-common scenario: Someone gets a tax return and decides to use it to upgrade their computer or another high-value item. Their tax return isn’t big enough to cover the cost of the entire computer, so they put the rest on a credit card.
Now you’ve taken your tax return and somehow used it to get into even more debt.
I’m all for using your tax return to put toward big items you’ve been saving for. Just make sure you have enough to buy them outright rather than going into debt to buy them. The only exceptions to this would be using your tax return to help fund a car or house downpayment.
2. Spend it on unplanned purchases
When I was in my early twenties, I would be so excited every year when I received my tax return. I though of it as free money that I could spend on whatever I wanted.
But instead of intentionally putting it toward my financial goals, I’d spend it mindlessly on clothing, take out, and other things I didn’t plan for and didn’t really need.
It’s okay to spend your tax return on whatever is important to you, just be intentional about it and have a plan for that money!
3. Put it in a low-interest savings or checking account
Whatever you do, be intentional about what you do with your tax return. Without a plan, that money could end up sitting in a traditional check or savings account, not earning you anything. If you want to keep the money in savings, transfer it to a high-yield savings account so you can earn more interest than you would through your traditional bank savings account.
I know how exciting it can be to get a tax return and think of all the things you can spend it on. I also remember the analysis paralysis I felt when I wasn’t sure what the best use of that money was. I hope this post helps you decide how best to use your tax return this year!