Here are the 3 best things to do with your tax refund

Image source: Getty Images

Be sure to use your tax refund wisely.


Key points

  • Many Americans will receive a large tax refund this year.
  • This lump sum payment represents a great opportunity to improve your finances.
  • Paying off debt, building an emergency fund, and investing are some smart ways to use your tax refund.

Many Americans get thousands of dollars back from the IRS after filing their tax returns. The lump sum payment that comes from a tax refund presents a great opportunity. Rather than spending the money on purchases that won’t pay off, you can use the funds to improve your long-term financial situation.

While there are plenty of ways to put your refunded tax money to good use, here are three of the best things to do with the money the IRS sends you.

1. Pay off the debt

If you have high-interest debt, such as credit cards or payday loans, you can use your tax refund to pay off as much of your debt as possible.

By making a large payment, you can reduce your principal balance. This will reduce the interest you pay over time and bring you closer to permanent debt relief.

2. Strengthen your emergency fund

An emergency fund helps you avoid financial disaster if you face unexpected expenses or loss of income. When you have money set aside for emergencies, you have a financial cushion so you don’t have to borrow if you face an unexpected cost that you didn’t budget for. If you lose your job, get big medical bills, or can’t work due to illness, you can use the money you’ve saved to cover bills so you don’t face foreclosure, repossession or other serious consequences.

Unfortunately, many people have too little savings for emergencies. The standard recommendation is to have three to six months of living expenses set aside, but it’s common for people to have a lot less – or even nothing at all.

A large tax refund allows you to create an emergency fund or increase yours if it is too small. By being better prepared for unpleasant surprises, you will have a calmer mind and a more secure future.

3. Invest for the future

If you don’t have high-interest debt and your emergency fund is fully funded, investing for long-term financial goals can be a great use of your tax refund.

You can do this in different ways. If you’re saving for a major purchase, such as a down payment on a house, you can deposit the money paid back directly into your savings account. You can also contribute the money to a tax-efficient retirement plan, such as an IRA with a brokerage firm.

By investing for retirement in a plan with tax relief, you can actually reduce next year’s tax bill with this year’s refund.

Which option is right for you?

Ultimately, the best place to put your tax refund will depend on your current financial situation.

The important thing is to figure out how you can leverage that money to grow your net worth in the best possible way, based on what you currently owe and your current and long-term financial goals.

You can’t go wrong with any of these three suggestions, so think about which one will have the most impact so that your refund can benefit you for a long time.

The best credit card erases interest until 2023

If you have credit card debt, transfer it to this top balance transfer card guarantees you an introductory APR of 0% in 2023! Plus, you won’t pay any annual fees. These are just a few of the reasons why our experts consider this card a top choice to help you control your debt. Read the full The Ascent review for free and apply in just 2 minutes.