Smart Ways to Use a Tax Refund
When a big pile of cash lands on your lap, it’s natural to want to do something fun with it. And perhaps you can — after you’ve put the majority of that money where you need it most.
Here are some good ways to use your tax refund.
Save it for emergencies
What would you do if you got hit with a $1,000 medical bill or car repair? Setting aside an emergency fund can help you avoid going into debt when unexpected bills crop up. Experts suggest keeping six months’ worth of living expenses in an easy-to-access savings account at a financial institution like Bellwether Community Credit Union.
But if you’re carrying a lot of debt, think about starting with a mini emergency fund of $1,000 for now so you can pay off more of what you owe.
Pay down debt
Credit card debt is especially toxic, both because it can exert downward pressure on your credit score and because the typical account has relatively high interest. Paying finance charges can make it awfully hard to reduce balances.
Putting your tax refund toward credit card debt can have a big immediate impact. Your credit score might go up when you reduce your balances. And if you can manage to pay off one card entirely, you’ll be eliminating a monthly payment, so long as you avoid using it.
Contribute to a retirement fund
If you’re like most people, your retirement savings could use a boost. Consider funneling that refund into your 401(k) plan by increasing your contributions, or put it in an individual retirement account, or IRA. Putting the money in a traditional IRA will reduce your taxable income for the year when the contribution is made, making a refund next year more likely. Money put into a Roth IRA, on the other hand, won’t reduce your tax bill in the short term, but both contributions and investment gains can be withdrawn tax-free in retirement.
Change your withholdings
Of course, a big tax refund means you’ve been making an interest-free loan to Uncle Sam all year. Adjusting the amount of taxes withheld from your pay will put the money in your wallet sooner. But don’t forget to do something smart with the extra cash — like increasing your retirement contributions or paying down debts a little faster.
Once you’ve used most of your refund responsibly, don’t forget to keep a little bit to treat yourself to a massage or a nice dinner. You deserve a reward for not blowing it all at the mall.
Virginia C. McGuire, NerdWallet
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