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Got a Tax Refund? 5 Best Things To Do With It
If you’re a business owner or self-employed, tax season can be incredibly stressful. Deductions, credits, endless piles of receipts—and an expensive trip to the accountant to boot.
But the average American actually makes out pretty great when their refund check arrives. According to Business Insider, the average refund for the 2017 tax year was almost $3,000—not too shabby!
But don’t be bummed if your refund was on the small side—this means that you successfully kept more of your hard-earned dollars in your own pocket.
“Getting a smaller tax refund may be a smart move,” Lauren Lyons Cole, senior editor for Business Insider told the publication. “[Overpaying] your tax bill by withholding too much from your paycheck is basically an interest-free loan to the government.”
If you got a refund, it’s time to make your money work for you. Here are five ways you can invest your tax refund for maximum returns.
1. Sock It Away in Savings
Americans are in a savings crisis. According to CNN, the average American doesn’t have enough money set aside to cover unexpected expenses like a medical emergency or job loss.
If you have to keep an eagle eye on your budget and your bank account, consider putting your tax refund aside to help beef up your savings and give you peace of mind.
“Your emergency savings is a buffer between you and high-interest-rate debt when unplanned expenses arise," Greg McBride, the chief financial analyst for Bankrate, explained to CNN. "Nothing lets you sleep better at night than knowing you have money tucked away to cover unplanned expenses.”
Most financial advisors suggest socking away three to six months of critical expenses—think rent or mortgage payments, car payments, groceries, and utilities. And if you’re self-employed, you’ll want to save even more. That way, an unexpected doctor’s visit or a car repair bill that creeps out of sight won’t send you reaching for your credit card.
Even if you’ve paid off your credit cards or have other money invested in a 401(k), you still need an emergency fund, says Mitchell Hockenbury, a certified financial planner.
“Good credit is nice; decent-sized index investments are nice, too,” Hockenbury told Lifehacker. “But neither of them are for emergencies.”
“‘Good credit’ simply gives you the opportunity to take out a loan,” he pointed out. “You still need to pay off the charges.”
2. Eliminate Credit Card Debt
As interest rates continue to rise, carrying credit card debt will make you feel the financial pinch.
If you got an unexpected tax refund this year, consider putting a large chunk of it toward eliminating debt. Not only will you save yourself expensive interest fees in the long term, but you’ll also free up your available credit—which raises your credit score.
Still struggling with carrying debt every month? The best way to eliminate credit card debt is to master your monthly budget. Only spend money you’ve already earned and allocated, says Jesse Mecham, founder of You Need a Budget.
“A lot of times people are spending money they haven’t earned yet,” Mecham told Consumer Reports. “We want people to be in a situation where a dollar they spend today was earned at least 30 days ago.”
Learn more about making a budget here.
3. Open an IRA
Even if you already have a 401(k) through your employer, an IRA can help you save money on taxes and build a nest egg for retirement.
Contributions to a traditional IRA account are tax-deductible—but you have to pay taxes on your withdrawals. If you decide to open a Roth IRA, your contributions have already been taxed, so you don’t need to pay taxes down the line.
“There aren’t many things in life that are free, but the idea is that you put money in and as long as you wait until 59 1/2 years, all of the earnings come out tax-free,” certified financial planner Herbert Hopwood told Bankrate.com, as he explained the upside of the Roth IRA.
“That is a huge benefit, especially when someone is young, because the money could compound and it could be worth 10 times what they put in or more,” Hopwood added.
4. Pay Down Your Mortgage
If you’re not worried about sending your kids to college next year, it might be worth using your tax refund to pay off your mortgage earlier.
According to personal finance expert Dan Caplinger, making additional payments on your mortgage can help reduce the amount of interest you’ll pay over the life of your loan, free up cash for other expenses, and build equity.
“A typical 30-year mortgage at today's average interest rate of 4.65% will involve your having to pay almost $257,000 in interest on a $300,000 loan,” Caplinger explains at USA Today.
“In the first month of your mortgage alone, almost $1,165 of your $1,550 payment goes toward interest, leaving just $385 to pay down principal,” he adds.
There are often advantages to knocking off more of your principal—but the math is different for every homeowner. If you have a major expense on the horizon—like college tuition—you may want to consider putting your refund toward that, instead.
“[If] you’re applying for need-based education aid for your kids, a paid-off mortgage or a lot of home equity can count against you at colleges where equity is considered money in the bank,” explains personal finance expert Dana Dratch at Bankrate.com.
Instead, Dratch suggests, extra savings might be better off in an IRA or Roth IRA.
5. Invest Wisely
Sometimes it’s hard to take a small risk with “extra” money like a tax refund. But if you invest your money wisely, you might see good returns by the end of the year.
New to investing? Start small, perhaps by investing in a fraction of a share, suggests Avi Lele, the CEO of Stockpile, an online brokerage firm that allows investors to do just that.
“If you get a $150 tax refund and Amazon is trading at $1,500 per share, you can purchase a tenth of a share,” Lele explained to U.S. News & World Report.
“A tax refund is the perfect way to kick-start an investment plan to build wealth for your future,” he added.
Interested in taking a bigger risk? Consider using an online brokerage that will help you make passive investments in bonds, mutual funds, and ETFs.
You’ll experience less volatility than chasing after high-performing stocks—and you’ll take pressure off yourself by eliminating the need to do excessive research. Hey, if Warren Buffet says passive investments are the best options for most first-time investors, who are we to knock it?
Learn more about investing for beginners here.
You don’t need a side hustle to take advantage of every dollar that comes your way. Even tax refunds can be put to work. Whether you put every penny of your refund in an emergency savings account, pay down debt, or invest in the stock market, these five strategies will put you on the path to financial freedom.
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