It may be tempting to throw caution to the wind when getting a tax refund, but the experts say to think hard before doing that.
In 2015, the IRS issued 109 million refunds, and the Treasury Inspector General for Tax Administration said the average amount was $2,701. It’s fair to speculate 2016’s tax refunds could be close to these figures as well.
Rather than immediately book a cruise or make a high-dollar purchase of any kind, why not think critically about these funds and consider one — or more — of these financially savvy ways to spend your tax return?
Pay down debt
Personal finance powerhouse, Suze Orman, advises on her website, "Don’t you dare spend that money on a vacation or a new flat screen. Or anything that qualifies as a ‘want.’ You are to focus on needs first."
Paying down doesn’t necessary mean paying off debt. Place particular emphasis on the credit cards in your wallet with the highest interest, and pay those down first. Don't deplete your finances, though, because you still need an emergency fund in case something comes up. Once your debt is paid down, work to lower your interest rates with creditors.
Contribute to an IRA (90/10 rule)
The 90/10 rule means that for those who would rather not max out their contributions to an IRA, they should consider adding 90 percent of their refund to an IRA and use 10 percent for a personal reward, like that big-ticket item or possible vacation. Two of the most common retirement accounts to contribute to are traditional or Roth IRAs.
If you opt for the traditional IRA, you will receive a tax deduction each year. However, with a Roth IRA, withdrawals in retirement are tax-free. No matter which choice you make, it's dependent upon eligibility and rules outlined by the IRS. Ultimately, you’ll be contributing the majority of your tax refund to your retirement account while still having a little left over for anything you want!
Create a rainy day fund
Establish an account for at least six months of household budget expenses if one doesn’t already exist.
"Most experts recommend setting aside four to six months' living expenses," writes Michelle Crouch of Nasdaq.com.
Because dollars are becoming increasingly harder to stretch in today’s economy, financial experts suggest beginning with your tax refund. Emergencies crop up all the time, ranging from identity theft to unexpected vehicle repairs. Having a rainy day fund to handle these issues is imperative.
Remodel your home
Do you need new appliances? Does your roof need repair or replacement? Instead of racking up additional credit card debt (because we're paying that down, remember?), use your tax refund toward necessary home repairs or improvements. that you’d typically be tempted to use a credit card for.
Take stock of your house and look around for areas in need of improvement or repair.
Instead of receiving a substantial tax return next year, why not give yourself a raise this year? If you are receiving a significant annual tax return, this means your withholding is higher than necessary, and you’re essentially providing a loan to the government. Consider a discussion about your W-4 with your payroll or human resources department to determine your ideal rate of withholding to give yourself a little extra money each month.
According to Credit.com, "No matter how you choose to deal with your taxes, it’s worthwhile to regularly evaluate your withholdings."
Think about how much you could save or how much faster you can get out of debt with a little more money at your disposal!
Just be sure not to adjust your withholding too much – otherwise, you will have to pay penalties at the end of the year.
If you’re one of the more than 100 million U.S. citizens expected to receive a tax refund this year, resolve now to invest in yourself. Whether using the funds to pay down debt, contribute to an IRA, create a rainy day fund, or remodel you’re actually setting yourself up for a better future.