If you’re eagerly anticipating a tax refund in the coming weeks, you have good reason to be optimistic: The IRS reports that about 77% of tax returns filed last year generated a refund, and the average refund was $2,815.
Although what may appear to be a gift from the government is actually a delayed receipt of your own money, the best use of those funds is not always obvious. This year, the question is even more complicated, as many households face mounting financial pressure from inflation, rising interest rates and the expiration of government assistance programs linked to the pandemic. Advance child tax credits, for example, which offered families monthly checks based on their income and number of dependents, have ended pending further action from Congress.
“For many people, advance child tax credits have become part of their budget, so you should consider saving your tax refund and using it to supplement your monthly budget in the future,” says Tommy Blackburn, a certified financial planner at Newport News, Virginia. . “That can help with monthly cash flow,” he adds.
Another option is to adjust your withholding to each paycheck so you don’t pay more tax than you need to. But, Blackburn adds, some people prefer to receive a lump sum each year as a method of forced savings.
While your refund priorities depend on your particular situation, there’s room in almost every budget to spend at least part of your refund check on something fun, too. Here’s a roadmap to help you decide what to do with the money:
SAVE FOR THE NEXT EMERGENCY
“Think about your short-term security first,” suggests Vince Shorb, executive director of the Las Vegas-based National Council of Financial Educators, which supports financial fitness educators. “There’s a lot going on, from COVID to inflation. I want to make sure people have food on the table and gas to get to work,” in case of an emergency like a job loss or an unexpected expense, he says. That means putting money in an emergency savings fund before any other priority, including paying down debt.
“With inflation, you want to save a little more than normal to plan for those skyrocketing gas and food prices. We don’t know what’s going to happen next,” says Scott Alan Turner, CFP in Aledo, Texas. While financial experts often cite a goal of having three to six months of expenses saved, a more realistic goal may be to save between $500 and $1,000, or at least half of your refund. Given rising prices, Turner says it’s best to save more if you can.
“If your industry is downsizing, you’ll need a bigger emergency fund,” Shorb says, because it might take longer to find a new job if you lose your current one.
DISCHARGE HIGH INTEREST DEBT
With interest rates expected to rise this year, credit cards and other variable-rate debt are likely to get more expensive, making using refund money to pay it off a smart move, says Mike Biggica , CFP in San Francisco. He suggests paying off any debt that has an interest rate of 6% or more and also focusing on student loans, medical debt, and anything else that has a variable rate.
Maggie Klokkenga, a financial coach and CFP in Morton, Illinois, suggests using an online debt calculator to see how making additional debt payments can speed up the debt-paying process. That can help you decide whether to pay off your smallest debts first or your largest, high-interest ones. “You can see how quickly you can have it all paid for,” she says.
MAKE ROOM FOR OTHER GOALS TOO
If you already have your emergency fund and high-interest debt, Klokkenga suggests putting your cash back into high-yield online savings accounts dedicated to different goals, like a Cabo vacation or retirement. “When it’s not in his checking account, it’s harder to access and it gives him pause before he can get the money,” she says.
Increasing your contributions to existing retirement accounts, like a 401(k), is another solid option, says Biggica. “For people who are not yet maxing out their 401(k), that increased contribution makes them feel more secure and accountable.”
In some cases, you can load your contributions in advance, adds Biggica, which means you reach the annual contribution limit before the end of the year. As a result, your take-home pay will be higher in November or December, offering flexibility to pay for year-end costs such as vacation expenses.
ENJOY WITHIN LIMITS
After taking care of emergency savings and debt payments, there may not be enough left over from your refund to make a huge purchase like a car, but Turner suggests doing something nice. “Go out and celebrate with something frivolous and entertaining: a nice steak dinner, new designer jeans, concert tickets,” he suggests. His guideline: Plan to spend about 10% on fun. For the average refund recipient based on IRS numbers from last year, that’s about $280.
It probably won’t finance a vacation, but it could significantly improve your weekend plans.
. Kimberly Palmer is the personal finance expert at NerdWallet and the author of “Smart Mom, Rich Mom.” Email: email@example.com. Twitter: @KimberlyPalmer.