Doing your tax return may not be a thrilling experience, but the prospect of getting money back can be motivating. Last year, nearly
three-fourths of filers received a refund,
with an average amount of $2,873, according to Internal Revenue Service (IRS) data.
Not sure what to do with tax refunds? If you overpaid on your taxes and expect to get some of it back, you might be dreaming about a fancy new gadget or a relaxing getaway in the sun. Those purchases offer a nice short-term boost, but there are other ways of using that money with a more lasting benefit.
Here are some options to consider before spending your tax refund.
If you are saddled with loan or credit card balances, any influx of money is a perfect opportunity to lighten your load. According to a 2021 Bankrate survey,
54% of adults in the U.S. have a credit card balance,
with half of them carrying revolving debt for more than a year. Paying down those high-interest forms of credit is a good priority.
You may have less expensive debt, like a
student loan
or mortgage with a low interest. You could reduce those balances, too, if it helps you sleep easier. But you may find that you'll get a better return putting that money to other uses, especially when you factor in
tax breaks for interest on certain types of loans.
Build your emergency savings
Life is unpredictable—you simply don't know when a job loss or major illness will arise, potentially creating a financial crisis. That's why many financial advisors recommend having an
emergency savings
fund big enough to cover your expenses for three to six months. If you have a family or lack job security, you may want an even bigger cushion.
Consider placing that money somewhere you're able to access quickly and where your deposits aren't at risk of losing value. Federally insured, high-yield bank accounts fit both criteria. Online accounts often pay a higher interest rate than brick-and-mortar banks, enabling your money to potentially grow more over time.
Contribute to your retirement account
Dropping a tax refund into a retirement plan can be one of the
best ways to maximize dollars,
particularly for younger investors. A contribution of $2,000 that generates an annual return of 7%, for example, would grow to $3,934 in 10 years. In 20 years at the same rate, the same contribution would grow to $7,739. And if you are eligible to put your money into a
Roth IRA,
you won't have to pay tax on qualified withdrawals.1
Most 401(k) plans
don't accept lump-sum investments,
but you could increase your payroll contributions and use the refund money to supplement your reduced take-home pay. For 2022,
workers can invest up to $20,500
through a workplace plan. People age 50 or older are able to contribute an extra $6,500 through the catch-up provision.
Invest in your short-term needs
Investing in a qualified retirement account may not make sense for you. Perhaps you've maxed out your allowable contributions for the year, or you plan to use the funds before you reach retirement age. An alternative to think about is
learning more about investments
and putting the money in a
mutual fund
or brokerage account.
You won't get the tax deferrals of a 401(k), but you will still have the potential to grow your assets by participating in the markets. It may be a smart play for someone who wants the flexibility to withdraw their funds at any time without triggering a costly penalty.
Start a college fund for your kids
The
average out-of-state student is paying
$22,698 a year to attend a ranked public university in 2022; the average private university charges $38,185. And if the financial strain of getting a college degree seems tough now, history suggests tuition is likely to be even higher in the years ahead.
For parents with minor children, tax refunds present a great opportunity to build a
529 education savings account.
The money you take out of it for qualified college expenses—or possibly private K-12 costs2—is tax-free. Depending on where you live, your state may offer
income tax deductions
on the money you contribute as well.
There's nothing as satisfying as lending support to those who need it most. Consider making a difference by giving at least part of your refund to a
charitable
organization that reflects your values. You may find it's easier to donate using a chunk of unexpected money you hadn't factored into your budget.
Financial planning
is all about balancing your near-term well-being with your long-term needs. That is to say: You can still use some of your tax overage on something fun, like a new kitchen appliance or a getaway with friends, but prudence is key.
If your
emergency fund
needs a boost or you're not on track with your retirement contributions, you may want to set aside the majority of your refund for those higher-priority goals, but that doesn't mean you can't treat yourself. Before the refund arrives, think about the percentage that you're comfortable using today—perhaps 10% or 20%—and put the rest toward longer-range needs.
Deciding what to do with tax refunds
Still not sure about the best way to use your tax refund? Based on your unique circumstances and long-term goals, our financial advisors can recommend options that fit into your broader wealth management plan.
Find a financial advisor near you
and start on the path to greater financial freedom.