Let’s start with a basic tenant that you may already know: a large tax refund isn’t something to jump up and down about, unless you’re angry. A refund is exactly what it sounds like: a return of cash that you overpaid to the government. It’s money that could have been used on your craft, credit card debt or cash reserve. Instead, you sent the money to Washington and let them hold it for you.
Guess what interest rate you charged the government while they held your money?
That’s correct. Zero.
Still, if I had to choose between a refund and owing additional taxes, I’ll take the refund as the lesser of two evils. Refunds for many people are a big chance to fix past financial missteps. If you’re going to receive a refund this year, there are at least two mistakes you should avoid:
- Making a down payment on more debt. Nothing is worse to me than to use a tax refund as a down payment on more debt. Although sometimes it’s unavoidable, creating new debt usually comes with new problems.
- Buying toys. A sports car, motorcycle or boat can be a nice option if your financial house is in order, but it seems that too many people forget long term goals before they create short-term fun.
There are a number of smart ways to use a tax refund. Here are 10 of my favorites to get you started:
- Create an emergency fund. You know that safety net money that you should have already set aside but never got around to creating? This is your opportunity. Tip: Open a new account to make sure you don’t commingle emergency money with your day-to-day expenses.
- Pay off a credit card. If you’re able to wipe out some debt with your refund, there’s an additional benefit: you’ll also free up some cash flow because you won’t have to pay the monthly bill anymore! Don’t let this new cash flow go to waste. Use the monthly money you save to contribute more to your savings account. Tip: make sure and call the credit card company to cancel the account. This will help you avoid annual account fees.
- Make an IRA contribution. Rather than wait until the end of the year to come up with IRA dollars, do it now. If you’re eligible, a Roth IRA is a nice choice because money grows tax free for retirement. Tip: Because nearly any investment can be inside of an IRA, make sure and ask about fees and risk before investing.
- Fund an education plan. According to FinAid.org, the cost of a college education is growing at double the global inflation rate. That means you’ll need some robust savings. 529 plans are fantastic ways to save for higher education expenses. While you’re at it, open a Upromise account for free to earn additional college money. Tip: ask friends and relatives without children to join Upromise also. It’s free for them and can add more money to your account if they specify you or your child as the beneficiary.
- Create a filing system. Maybe this is the chance to clean out the clutter in your life. A great filing system pays dividends as long as you use it! Tip: Invest in a good organization-decluttering book to use your system well. I like David Allen’s Getting Things Done.
- Hire a coach. Reinvesting a tax refund to perfect your craft is rarely a bad idea. By investing in coaching or classes, you’ll increase your chances of earning more money in your chosen field. Tip: Interview a few different coaches before settling on one. Ask about professional designations and notable accomplishments.
- Turn your hobby into a business. If you’re not yet a professional in your craft, maybe now is the right time to make it official. Find a good attorney, draw up legal papers to open your business, have cards printed and begin life as an entrepreneur. Tip: Ask your accountant for names of good attorneys to set up your business.
- Dress for success. How many times have you met someone and thought they’d do so much better with decent clothing. It’s easy to go over the top here, so be careful. A few well-placed pieces can turn a tired wardrobe into a whole new look. Tip: Look online for style guides. There are many frugal fashion sites online that can help you maximize your dollars.
- Major repairs or home efficiency additions. While fixing your car can make it easier to meet clients, home efficiency options like new windows or insulation can help lower your utility bills. Tip: Ask about potential tax credits when adding energy efficient products.
- Support a charity. If you didn’t expect a refund, why not help a good cause? It’s not just good karma–you’ll also receive a nice tax deduction you may be able to use on next year’s tax return. Tip: If you’re unfamiliar with a charity, ask about 501c3 status before giving them money. Only gifts to 501c3 organizations are tax deductible.