8 Smart Things to Do With Your Tax Refund

by Darwins Money on 12 April 2011 (9 comments)

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With millions of Americans due to receive tax refunds in the coming weeks, it's worthwhile to think about what to do with that mini-windfall. After all, since refunds are somewhat unpredictable, chances are you may not have a plan in place just yet. Here are 8 ideas to get the most out of your refund this year:

1. Pay Down High Interest Debt Immediately

I intentionally listed this as the first priority. Whether it's 20% interest on a credit card or 9% interest on a car loan, chances are that even if you invested your refund in equities or other conventional asset classes, you wouldn't get a higher return than the reduction in high interest debt. Plus, debt write-downs are guaranteed and involve no uncertainty or volatility. As we've seen on numerous occasions, including recent events in Japan, stocks are highly volatile.

2. Build an Emergency Fund

This one takes a close second. Even if you have some high interest debt, if you have no emergency fund whatsoever, you need to start one right away. This isn't exactly the hottest job market. It would behoove you to plan for the unexpected. While your refund might only equate to a month or two of post-tax spending, it's better than having no buffer at all. Any calamity ranging from job loss to a medical emergency could force you to ring up more high interest credit card debt, ruin your credit, or worse. An emergency fund is there to help you sleep better at night and weather the unexpected—because life happens. Think of it as insurance and hope you never need it.

3. Upgrade Your Home and Get Another Refund Next Year

Fortunately, recent tax legislation included some tax credits for green initiatives and stimulus efforts for the appliance, HVAC and window industries (see 2011 Energy Tax Credits and What Are Energy Tax Credits for full details).

While the tax credits aren't as generous as they were from 2009-2010, homeowners can still receive credits totaling several hundred dollars while realizing lower energy costs for the life of the home. Now that's "reinvesting" that refund.

4. Start Investing

If recent headlines have taught us anything, it's that market and government forces are forcing more costs onto employees by way of higher health care contributions, higher pension contributions, lower wages and in all likelihood, some reduction in future Social Security benefits. With that in mind, it's important to start investing early and be more self-reliant in your later years. By investing just a portion of every refund you greatly reduce the burden on your budget in retirement. If you're not already an experienced investor, consider focusing on a simple low-fee index mutual fund or ETF.

Not sure how to make the best of your IRA contributions? Check out this IRA Tax Calculator to estimate your IRA contributions.

5. Save for College

With college costs rising by roughly 2-3 times the rate of inflation annually, it's no surprise that even a state school education is out of reach for many American families. Realistically, we're talking over $100,000 per child in today's dollars. It's therefore important to start saving while your children are young, in either a college credit purchase plan or a self-directed investment plan.

6. Start a Small Business

There are so many ways to make money online these days I couldn't possibly list them all. Either online or through a particular skill set you possess, perhaps you can roll your refund into a new business. Some online examples include starting a new blog, or even buying a blog with existing traffic and income.

7. Refinance

Here's another opportunity to turn a few thousand dollars into years of annual savings. While interest rates had run up a bit over the past few months, they dipped again recently following the Earthquake in Japan when investors fled into Treasuries. The dip in the 10 Year bond yield drove mortgage rates back down so refinancing may be more attractive than it was just a few weeks ago. Often times, a refinance will run a few thousand dollars in closing fees, but if the monthly savings make sense, go for it!

8. Enjoy Life (Experiences over Materialism)

There's more to life than making and saving money. Sure, maybe it's high time you splurge and buy that iPad 2. But maybe you want to enjoy a life experience with a significant other or family. Jump on a Groupon or LivingSocial weekend getaway. Go skydiving. Learn how to fly-fish. Plan a big surprise birthday party or anniversary getaway. With an unplanned windfall, if your finances are in order already, consider a life experience you'll take with you. Technology is obsolete within months, life experiences are forever.

I hope those ideas got your creative juices flowing. Personally, I'm using this year's refund for 529 savings, topping off our 2010 IRA contributions and investing in our business we just started. And for you tax procrastinators out there—if you haven't even started your taxes yet and you're itching to know what your refund's going to look like, check out this Tax Refund Calculator for some instant gratification!

What are your refund ideas?

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Will Chen's picture

I'm definitely taking advantage of the energy tax credits. Investing in an energy efficient home will save me lots of money in the future.

Guest's picture
Ishanshde

I try to either get nothing back from the Feds every year , or I actually have to pay. I had a decent tax bill this year, but I would rather pay than give the government an interest free loan for a year.

Full disclosure: I have no consumer debt, and my only monthly bills are a mortgage at 4.25 percent and some student loans at 2.94 percent. I was lucky to have a great financial education from my parents and have been a saver for many years.

If you are in good financial shape, think about what you can do with the refund if you had it throughout the year.

Great article. If you are getting a refund, smart things to do with it.

Ray Jamali's picture

Starting a small business can not only save you on taxes but potentially provide extra income.

Guest's picture

I like prioritizing the list. We've actually recently taken care of #1 & 2 recently thanks to the help of the tax return and it feels great! Very motivating. I think it can be a temptation to go and blow the extra money that comes in, but this is a great way to help yourself and finances by creating a list and making priorities...and to maybe have a little fun with it.

Darwins Money's picture

We're mulling over a window or door replacement as well. The credit isn't what it was in prior years, but it's still a few hundred bucks nonetheless - with an annual ROI to boot!

Guest's picture
Jackson

Any refund I get goes into a few different places: emergency fund, paying down debt, and my kids 529 college fund. I always keep a few dollars to take the spouse out to lunch at a decent restaurant.

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Tanya

I always use my refund to bulk up my emergency fund.

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hloom

Investing / starting a small business seems to be a wise choice to me since it brings extra income (and more taxes... but that is another story)

Guest's picture

Probably the smartest thing you can do with any windfall. Like getting an instant return equal to the interest you were paying on that amount of debt.