What to Do With Your Tax Refund
Make your tax refund work for you
It's always exciting when tax refund time comes around. If your deductions earned you a nice chunk of cash back, why not put it to work?
There are dozens of smart ways to handle your tax refund. Consider using your tax refund to pay down your debt, save for college, invest, or start a side business. Here are just a few things you can do with your tax refund to make the most of it.
Pay Down Debt
There are two ways you can pay down your debt—either apply your tax refund toward the debt with the highest interest rate or apply your tax refund toward the debt with the smallest balance.
Paying off your highest-interest-rate debt will save you the most money, but paying off the smallest balance might provide the psychological sense of victory that keeps you motivated to continue paying down your debts. Which of these two popular debt payoff methods you use is up to you. Either way, if you're struggling with a mountain of debt, you can use your tax refund to accelerate the climb.
Save for College
You can invest the entire tax refund as a lump sum in a 529 College Savings Plan that you’ve set up for yourself, your child, or a family member. You can also stick the refund into special savings account that you’ve designated for expenses you’ll incur during your student years that may not be 529-eligible, such as the cost of paying for car insurance.
Contributions to a 529 plan are tax-deductible in many states (though not at the federal level). That means if you invest your tax refund into a 529 plan, it may lower your taxable state income next year. Check out your state's current 529 tax laws to be sure.
Build Your Emergency Fund
This is probably the single most important thing you can do to maintain strong financial health and prevent yourself from sliding into debt. Your emergency fund should contain three to six months of living expenses and should be held in an easily accessible, liquid account, such as a savings account or a money market account.
You could use a big tax refund to shave months off of your emergency savings plan and put yourself in a better position to weather future financial storms.
Invest for Retirement
Speaking of taxes, why not use your tax refund to reduce your future tax bill? You can contribute $19,500 of your paycheck per year to your 401(k) if you’re 49 or younger, and an additional $6,500 if you’re 50 or older.
All 401(k) contributions are made on a pre-tax basis, so you won't pay taxes on that money until you withdraw funds in retirement.
Alternatively, you can contribute $6,000 to your Roth IRA if you’re 49 or younger, or $7,000 if you’re 50-plus. Not everyone is eligible to contribute to a Roth IRA, though. The eligibility is dependent on your income and your marital filing status.
In 2021, a married couple filing jointly can make a full contribution if their earned income is $198,000 or less. A single filer can make a full contribution if their earned income is $125,000 or less. Beyond those income levels, the amount that you’re able to contribute gradually diminishes until you cross a threshold, after which you can’t contribute to a Roth IRA at all.
Start a Side Business
The adage “it takes money to make money” is true. Blindly throwing money at a business is a bad plan, but strategically investing in a side business might earn you solid rewards down the road.
You can invest your tax refund in the supplies you’d need to start selling jewelry or reupholstering furniture. Or you could register a website and start selling products online. You can even buy a lawnmower or a leaf-blower and start a weekend business doing neighborhood yard maintenance. Alternatively, consider saving for a down payment on a rental property. Take some time to consider what you're good at—and what you could launch with just the funds from your tax refund.
The Bottom Line
Don’t run to the nearest shopping mall with your tax refund—use it to improve your financial future. You worked hard for that tax refund. Now it’s time to make your refund work for you.
And once you have put that refund to good use, think about how you can avoid getting a tax refund in the first place next year. That way, you can put that money to work right away.