Tax refunds are the only windfall many people ever see, and year after year there's a big temptation to blow it all on something fun. Nothing wrong with that if your finances are in order, but if not, there are better ideas.
Last year, more than 64 million Americans received an average tax refund of $2,985, the IRS says.
Where did they spend it? Everywhere. On everything from everyday expenses to vacations and big-ticket items like giant TVs, according to a National Retail Federation survey. About two in five said they used the windfall to pay down debt.
As Stacy suggested, changing your tax withholding on your W-4 at work is one way to make sure you don’t waste a refund – you’ll get to keep more pay year-round instead of receiving a fat check from Uncle Sam.
But if you’re not sure what to do with your refund this year, here are some ideas that will make you richer – either by protecting your bottom line (from fees, interest charges, and frivolous spending) or by offering memorable new experiences…
- Pay down debt. Resist the urge to splurge. Use your refund to reduce high-interest balances. Not only does this cut down the interest charges and overall amount you owe, it may also improve your credit score by lowering your credit utilization ratio. And a better score can mean easier access to credit at better rates.
- Create an emergency fund. Living paycheck to paycheck often makes it difficult to do anything else – there’s never enough money to get ahead. Use your refund to build a financial cushion, ideally enough to cover at least three months of living expenses. That way, bills always get paid on time (no late fees), you never need a cash advance (no high-interest charges), and you can stock up on bargains at the grocery store. And the peace of mind: priceless. If you’ve already got that covered, set the money aside for something you know you’ll have to replace eventually, like your next car.
- Save on insurance. Speaking of vehicles, many car insurance companies offer a discount if you pay the six- or 12-month premium in full. Use a chunk of your refund to do that, and put the rest in a savings account so you can raise your deductible and lower your rate even more.
- Get a bigger refund next year. Our recent story Tax Hacks 2012: 3 Ways to Supercharge Your Refund offered ideas for both getting ahead and getting more from Uncle Sam next year. Make energy efficiency improvements to your home, pump up a retirement plan, or donate your old stuff to charity (to make way for the new) and your tax refund will be doing double duty.
- Start a business. Use your refund as seed money for a small side business or some classes in a skill or craft you’ve always wanted to learn. You could launch a website and sell your own arts and crafts, for instance, or start a garden and sell your extra fruits and veggies at a farmers market.
- Think big. If you’re going to blow the money, make it an event to remember – maybe take the family skydiving and get video of it – instead of frittering the refund away in forgettable ways. There are still ways to save, whether you want a traditional vacation for cheap or a getaway in the Italian countryside.
- Invest. Think for the long term instead of right now. You could start funding a 529 college savings plan, or open an individual retirement account for yourself – 10 percent a year for two decades will turn your $2,000 refund into $13,000, and you can include future refunds to make it balloon even more. Just remember these 5 Things to Consider for a Less Taxing Retirement.
If you haven’t filed yet, make sure you get the biggest refund you can. Check out other stories from our tax hacks series, like 8 Easy-to-Miss Deductions.