Getting a sizable tax refund can seem like winning the lottery. All at once, you’re a few thousand dollars richer.
It can be tempting to blow that cash without thinking, but you’re wiser than that. You know that your tax refund isn’t free money — it’s your money.
If you’re unsure of the best use of your tax refund, remember that it’s a portion of the hard-earned cash you worked for throughout the year and consider these eight smart ways to put that money to good use.
1. Build Up Your Emergency Fund
Saving cash aside for emergencies gives you peace of mind that you can financially weather a crisis. Unfortunately, many Americans have much less than the recommended amount for an emergency fund.
If you have less than three-to-six-months worth of living expenses, funnel some of your tax refund to your emergency fund.
2. Pay Down Debt
Relieve yourself of some of the pressure weighing down on you from debt.
If you’re a fan of the snowball method of debt repayment, put your refund toward one or two of your smaller debt balances. Once they’re paid off, work on your next largest debt.
If you’re more of a debt avalanche fan, use your tax refund to pay down a larger balance that has the highest interest rate. Even if you don’t pay it off completely, reducing the balance means you’ll pay less in interest.
3. Contribute More to Your Retirement Funds
Hopefully you’re already contributing to a 401(k) plan or individual retirement account (IRA), but are you maxing out your contributions?
The 2020 401(k) contribution limits are $19,500 for individuals younger than 50 or $26,000 for those 50 and up. This year, you can contribute up to $6,000 in an IRA if you’re younger than 50 or up to $7,000 if you’re 50 or older.
The more you add to your retirement accounts, the greater your money can potentially grow. Even if you can’t afford to increase the percentage of your paycheck that goes to retirement each month, you can use your tax refund to make a one-time, lump-sum contribution.
4. Save for a Big Bill
Think about what big expenses you have coming up on the horizon that you haven’t budgeted for — like your auto insurance premiums or getting braces for your teen.
If your monthly income can’t support such an expense in addition to all your regular bills and obligations, using your tax refund is a smart choice in lieu of dipping into your emergency fund or turning to credit cards.
5. Fill Out Your Sinking Funds
You’re probably juggling multiple savings goals. Maybe you’re trying to stack cash for a cross-country move while saving for a wedding. Or you’re saving to welcome a new baby into the family while putting money aside for your older kid’s birthday party and concurrently saving for a down payment on a minivan.
Each sinking fund — which is just a personal finance term for a pool of money you add to over time to break up a large expense — could probably use an influx of cash. Distribute a portion of your refund money to each savings goal — or funnel it all toward your most pressing need.
6. Invest in Yourself
Sometimes it takes money to make money. Is there a certification program you can take or a piece of tech equipment you need to enhance your career and help you get a better-paying position?
Or perhaps you have a business idea you’ve been wanting to get off the ground but just needed some initial capital.
Invest your tax money in something that’ll help you generate more income.
7. Save for Your Kids’ College Education
College is a big-ticket expense for most parents. Even with scholarships and financial aid, families can expect to have significant out-of-pocket costs.
Get in the habit of putting your tax refund toward saving for college to help offset your child’s looming tuition bill. A 529 college savings plan is a common option to store your funds.
If your kid is still in diapers, it may seem more practical to put your extra money toward more immediate expenses, like the cost of daycare. There’s always time to save for college later.
8. Make Home Improvements
Home upgrades can be expensive, but they can also increase the value of your home when it’s time to sell.
If your roof is due for replacement, you’ve got major appliances that are decades old or you simply want to give your kitchen a facelift, tap into your tax refund to take care of those home improvement projects.
Nicole Dow is a senior writer at The Penny Hoarder.