13 ways to use your tax refund

In 2021, roughly 75% of tax return filers received refunds. Total refunds came in at a whopping $355 Billion with an average refund of just under $2,800 (or about $230 per month extra that the average tax filer could take home in their paycheck).

Whether you planned to get a tax refund or it comes as a surprise, having a strategy for how you will use the funds is always a good idea. If you have a plan when the refund finally hits your bank account, you are more likely to use it in ways that support your current, short-term, and long-term goals.

Here are 13 ideas for how you can make the most of your tax refund plus an explanation as to why proactive and ongoing planning for your taxes is essential to making sure your money is working hard for you all year long – not just when you file your taxes.

The psychology behind your tax refund

You might be wondering what tax refunds and psychology have to do with one another. The link between the two may surprise you and, more importantly, determine how you use your refund. When it comes to tax refunds, we tend to categorize them mentally the same as we would a windfall or an unexpected influx of money. It’s a process called mental accounting and how we categorize money impacts how we think about and ultimately use it.

Windfalls are often spent and not used to help support current and future life and financial goals. To avoid a refund being seen as a windfall, it’s important to use what they call a pre-commitment device in behavioral economics. Put simply, it’s having a plan for how you will use the money in advance of actually receiving it. You are proactively committing to how you will use the money.

13 ways to use your tax refund

1. Boost your emergency fund

An emergency fund is a savings account set aside to pay for unexpected expenses big and small. It can give you peace of mind knowing you have the cash available for events like: car repairs, home maintenance and appliance repairs, job change or job loss, and unforeseen medical expenses.

An emergency fund is an essential element of a healthy financial foundation. It’s a buffer that protects you and your finances from unexpected expenses and helps you avoid having to rely on credit cards or other high interest loans. In general, you want to have three to six months worth of expenses in savings, but this number can vary based upon your personal situation.

2. Pay down (high interest rate) debt

If you already have an emergency fund, or you are at least well on your way to your goal, you should consider paying down, or off, existing debt. 

The first step is to get a clear picture of the debt you have, the balances for each loan, and the interest rates. Typically, it will make sense to pay off any personal loans and credit card balances as they carry higher interest rates than most other loans. Next, look to student loans and possibly car loans. Paying down a mortgage depends on your situation, other savings and investing goals, and desire to be debt free.

The great thing about paying off debt is that it comes with two benefits – you not only eliminate the debt itself but you also save money by eliminating the interest on the debt as well.

Example: Let’s assume you use your entire refund (we will use the average amount of $2,800) to pay off debt. Here’s how much you would save in interest alone in different scenarios:

• A credit card at 15% = $2,800 * 15% = $420
• A personal loan at 8% = $2,800 * 8% = $224
• Student loans at 5% = $2,800 * 5% = $140

And these figures represent only one year. If you continued to apply your refund, or increased your monthly payments, the benefits only compound.

3. Purchase Series I Bonds

With inflation a hot topic, people have been talking about Series I Savings Bonds which can offer protection against rising prices. Most people don’t know that you can use your tax refund to buy I bonds directly from the U.S. Treasury. There are limits to how much you can purchase in any given year, and you can buy up to $5,000 (per individual) if you elect to do so with your tax refund. 

You have to make the election when filing your taxes so proactive planning is key. Keep in mind that you cannot sell (redeem) your I bonds for the first 12 months so this is not a good use for your cash if you need the money in the next year.

4. Prepare for life events

You don’t always have to use your tax refund to save for a long-term goal as many experts may recommend. Yes, saving and investing for your future is always a good strategy but planning for today is also important. 

Use your tax refund to boost your savings for current and short-term life events and goals like getting married, preparing for and starting a family, buying a new or used car, buying or selling a home, or maybe even preparing for a job or career change.

5. Tackle the one thing you’ve been putting off

We all have at least one thing we are putting off. For many, at least when it comes to financial planning, it has to do with estate planning and life insurance needs. Whether you have been putting it off because of the hassle or the cost or it’s a new need because life has changed, these are critical items to put in place. 

A tax refund can be just the nudge you need to get the life insurance or estate planning documents you need to protect you, your loved ones, and everything else that matters most to you.

6. Supercharge your retirement savings

When it comes to retirement planning, every little bit counts. Use your tax refund to boost your retirement savings by increasing how much you contribute to your workplace retirement plan or by setting up and contributing to a traditional IRA or Roth IRA. 

For 2022, you can contribute up to $20,500 (if under 50) or $27,000 (if over 50) to your 401(k) and $6,000 (if under 50) or $7,000 (if over 50) to an IRA or Roth IRA. 

Even if you can’t put the full amount for these accounts away right now, adding a few thousand dollars or even increasing your annual contributions by 1% can have a material impact on your future savings. Here’s how to think about it:

Example: Assume you received the average tax refund of about $2,800. This breaks down to $230 per month. If you were to increase your monthly retirement savings by $230, you could save almost $40,000 over ten years and just over $300,000 over thirty years. We assumed an 8% annual return so your results may vary based upon your investment returns, but it’s clear that small changes can have a big impact.

7. Open a taxable investment account

If you are already contributing the maximum amount to your workplace retirement plan or even your traditional or Roth IRA, you should consider opening and funding a taxable investment account. When saving for your future, it’s not just about how much you make but how much you keep. The goal is to create different buckets of money that are taxed differently. 

Making pre-tax contributions to a 401(k) or IRA is a good thing, but you want to fund other types of accounts like Roth IRAs, health savings accounts, or even a taxable brokerage account. When you retire, having different accounts that are taxed differently will give you flexibility in creating tax efficient income strategies.

8. Fund your HSA

If you are eligible to make a health savings account contribution and you have not reached the annual limit, your tax refund can be a great source to top off your account. An HSA is one of the most powerful retirement security accounts we have available to us today because they have three tax advantages:

• You don’t pay taxes on your contributions.
• You don’t pay taxes on any growth.
• You don’t pay taxes when you use the money (assuming they are used for qualified expenses).

Healthcare costs are at the top of the list for retirement expenses, and an HSA can be a great tool to help prepare for them today.

9. Invest in your professional development and career

Investing in your career and your ability to earn income (you may hear this called your human capital) can pay the greatest dividends. Using your tax refund to pay for additional training, certifications, enrolling in an online course, attending a work-related conference or workshop, or really anything that can advance your career can lead to pay raises, promotions, and even new job opportunities. 

And when you earn more money, you can reinvest that into saving for current and short-term goals and, of course, your financial independence in the future.

10. Invest in your home

Owning a home can be a great investment in you, your family, and the life you want to live, and it can also come with a few added expenses. Your tax refund can be a great resource to put towards some of those smaller, or not so small, maintenance and home repair expenses. 

There are also more fun ways to use your tax refund like giving a room a fresh paint job to liven it up, buying some new furniture, doing some landscaping work or finally adding that garden, and maybe even investing in the home office now that you are spending more time working from home.

11. Education savings

The cost of an education – be it private school, college, or a postgraduate degree – has been rising for decades. With the cost of raising a child surpassing $230,000, which doesn’t even include higher education costs, the very thought of footing the bill and trying to avoid student loans can be a bit anxiety producing to say the least. 

Starting to save and invest for an education in the near-term or years off can be the smartest thing you can do to provide for a good education, reduce future debt, and help your son or daughter start their early adult years in a good position.

Use it to boost your savings for the future and look for an education savings account (also called a 529 savings plan). They offer tax-free growth and potentially tax-free withdrawals if you use them for qualified education expenses. Some states even offer tax breaks for what you contribute.

12. Give back through charitable contributions

It’s not often the first thing people think about around tax time, but planning for your annual charitable contributions should be something to consider all year and not just in December. If there is a cause or organization that you want to support, your tax refund can be a great source of funds to make your annual contribution. Make sure you incorporate this into a broader planned giving strategy to maximize your tax savings.

13. Reward yourself and have a little fun

Making smart decisions with your money isn’t just about saving for retirement. We can enjoy life today and save for our current and future financial goals at the same time.  Whether it’s an adventurous outdoor excursion, international travel, or something smaller like taking music or dance lessons, use your refund as the catalyst to have a little fun or to gain life experiences. 

We don’t always have to think about life experiences and vacations as expenses. They are important moments in life that allow us to recharge, enjoy the journey, and remain committed to the financial planning process.

From planning for your tax refund to proactive tax planning

A tax refund certainly beats having a bill to pay come tax time, but, while a refund is a nice and welcome surprise, it isn’t an ideal outcome. In reality, a tax refund is an interest free loan to the government for the entire year. Instead of having extra money in your pocket, you are essentially putting it in a savings account with the IRS and asking for it back when you file your tax return(s) and not earning interest along the way.

Instead of being reactive during tax season, be proactive in planning for the year ahead. Check your tax withholdings every 6 months or so to make sure you are on track from a tax perspective. The more moving parts (salary, bonus, commissions, stock options, capital gains, self-employed income, family and tax credits, etc) the more proactive you need to be. Questions to ask yourself before next tax season: 

• What personal changes will take place? – getting married, starting a family, buying or selling a home, moving to a new state?
• What professional changes do you plan on? – new job, promotion, new stock options or vesting, starting a business?
• What financial changes do you foresee? – change to income, retirement account withdrawals, realizing capital gains, selling a business?

Making smart, informed decisions with your tax refund is important, but proactive and ongoing tax planning can help you take more money home with every paycheck and put you in control of how you use it throughout the year.