John Gower, Analyst, NerdWallet
Each year, about 75% of Americans who file tax returns receive a refund. According to a survey conducted by the National Foundation for Credit Counseling (NFCC), more than half of those receiving refunds (58%) intentionally plan it that way.
So if you are a member of the group that’s been giving Uncle Sam an interest-free loan every year, what are you going to do with that money? Spend it? The average refund is about $3,000. That’s a serious chunk of change that would be better put to use in other ways.
How to maximize the value of your refund
Here are 4 simple ways to spend your tax refund that will improve your personal finances far more than a new wardrobe.
Pay down debt
Are you carrying a credit card balance? Pay it off if you can. If not, making a substantial payment will still lower your future monthly payments considerably. If you have more than one credit card to pay, pay the one with the highest interest rate first. Or, if your credit cards are under control, plunk down a big payment on your car or your mortgage.
Build up an emergency fund
Just like you wouldn’t leave the house on a cloudy day without an umbrella, you shouldn’t be without an emergency fund. Experts recommend setting aside at minimum enough to live on for six months, or a year if you have a family. This is money that should be kept accessible, so you can tap into it if you have unanticipated big expenses for home repair, medical care, or you find yourself suddenly unemployed.
Start or add to your IRA or 401(k)
IRAs and 401k plans are opportunities to put aside money now for retirement purposes. Since these plans are tax-advantaged, they are even more valuable than a typical savings or investment account. So if you’ve been avoiding retirement contributions lately, or have not even started a retirement plan yet, you could use your tax refund to turn that around in 2014.
Improve your insurance coverage
Are you squeezing by with little (or no) insurance coverage for your home, car or even your health? Then your tax refund may be best invested in an improved insurance policy for your family or property. Your monthly premiums will rise, but in the event of a catastrophe, you’ll be happy for the added cushion.
Just make sure to fully research your options and consider your personal situation. More expensive coverage may or may not make sense in all cases. For example, a healthy young adult may not need a premium health insurance plan but could benefit from better auto insurance if they rely on their car for work or school.
Rethink your withholding status
Now that we’ve given you some ideas on how to better use your tax refund, let’s float this idea: Why are you giving Uncle Sam an interest-free, 12-month loan? A $3,000 refund essentially costs you about $250 per month – money you won’t earn interest on and won’t see until sometime the next year.
What if you kept that money and saved it each month instead? Your $250, invested monthly in a savings or brokerage account would actually grow in value over the year. So perhaps you should consider adjusting your withholding to be more in line with what you actually need to pay in taxes and plan to break even with the IRS for 2014.