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Getting a nice, big income tax refund wisely is something millions of Americans look forward to. While it might seem like free money to many, it’s actually money that you have already worked hard for and overpaid, so when you are paid back it’s important not to waste it.
Sure, there is always room for a few splurges to treat yourself, but if you leverage your return in the right way you can enjoy greater benefits or security down the road. Here are seven ways to use your tax refund wisely.
1. Start A Debt Avalanche
If you carry any debt, getting a federal income tax refund can be one of the best ways to get out from under it. By using the debt avalanche method, you can often use the extra funds to greatly reduce or even eliminate a large, high-interest debt. This debt adds up fast and can come with crippling monthly payments.
Using your refund this way can instantly magnify the power of your return, and save you more over the course of the year. For example, if you get a refund of $3,000 and carry a credit card balance the same size at even a moderate APR of 15% you can save yourself hundreds in interest just that year (as well as the elimination of that monthly payment.) This extra financial breathing room can be invaluable.
If you don’t immediately need the funds to pay down high-interest debt, you should consider investing them. In many cases, those funds can begin working for you immediately. The catch is that this is a long-term place to put your money, and you can assume a relatively large tax burden if you end up pulling it back out too soon.
While you can certainly invest in specific companies, this is often more of a risk than most people are comfortable with when it comes to their money. Safer places for extra funds include ETFs or dividend funds.
3. Start An Emergency Fund
Sometimes it’s an emergency or other unexpected expense that gets us into tight spots. Planning for your next emergency, by starting to grow a financial cushion against it, can be one of the most effective ways to keep it from disrupting your life as much. Even a fund of $1,000-$2,000 can help guard against losing some or even all of a paycheck to car repairs, medical bills, or essential travel, for example.
4. Make A Retirement Fund Contribution
This often isn’t too high on the list for people who make regular retirement contributions with each paycheck. However, there are many situations where you can make “catch-up” contributions or other large, yearly contributions to reach contribution limits. The main benefit to this is the tax advantages you may be able to reap either now or later.
5. Pay Down Mortgage Principal
Being able to pay ahead on your mortgage can save you thousands in interest over the life of the loan. When making a significant extra payment, be sure you specify that it is a payment against the remaining principal. Each additional payment you make now is one less you make at the end of your term, when it’s been sitting and accruing interest.
6. Professional Education
Depending on your profession and career track, using your tax return for continuing professional education can bring you a significant return on investment. This can be a very strategic maneuver if the course or certification would put you in a prime position for promotion or a higher pay scale. For some jobs, this can be as simple as taking a second language to get a few extra dollars per hour.
7. Fulfill Entrepreneurial Goals
Many people have aspirations of starting their own business or expanding an existing small business. Using your tax return to help fund those goals can put you a step closer to making dreams of owning your own successful business come true.
Think Of The Big Picture
We all know people that get that tax return and seem to have it spent before it clears the ACH. But when you put a little forethought into how to make that money work for you and exercise some restraint, you would be surprised at how powerful your return can be.