Even when we expect our tax returns to bring a refund, we all dread preparing for the tax deadline. The arcane tax forms, instructions few can decipher and our increasingly complex financial situations make each year’s return seem more painstaking than the last.
Many personal finance experts recommend adjusting your withholding so that you don’t get a refund check in the spring (arguing that this amounts to giving Uncle Sam an interest-free loan for several months) when you could be putting that money to immediate use. However, for some people, having the government hold their money for them is the easiest way to accomplish their savings goals.
Tutorial: Personal Income Tax Guide
But wait! If you don’t have a plan for the money when that refund check comes, it could be all too easy to spend it. Instead of succumbing to impulse, consider these five options for letting the savings you accumulated last year bring you greater financial security and peace of mind in the years to come.
1. Pay Down Debt
If you have high-interest credit card debt, putting your tax refund check towards paying it off will likely give you greater returns than any other option. That’s because when the balance you owe to credit card companies goes down, the interest (or finance charges) you have to pay on that debt also goes down. Depending on your interest rate, you’ll be saving anywhere from 10% to 29% per year in interest on any portion of your balance that you manage to wipe out. The simple act of using your refund to pay off an extra $1,000 of debt this year could save you hundreds of dollars in future finance charges.
SEE: Understanding Credit Card Interest
2. Fund Your Emergency Savings
If you’re fortunate enough to not have any credit card or other high-interest debt, put yourself in a stronger position to stay that way by putting your refund check into your emergency savings account. This special savings account will allow you to cover any expenses in case of an emergency, such as being laid off from work or faced with unexpected medical bills. Instead of borrowing money from credit card companies at high rates or paying interest and penalties on a loan from your 401(k), a well-funded emergency savings account will put you in a position to lend yourself the money for free without jeopardizing your credit score or your retirement. Most people need the equivalent of at least three months’ salary in an emergency fund to feel comfortable.
SEE: Build Yourself An Emergency Fund
3. Save for Retirement
If your credit card debt is non-existent and you’ve got several months worth of living expenses saved up, consider yourself ahead of the pack. To strengthen your financial position even further, consider putting your tax refund check into a Traditional or Roth IRA. If you don’t already have an IRA established, why not use this opportunity to start one?
As long as you meet certain income requirements as defined by the IRS, you’re entitled to open a Roth IRA even if you already have a 401(k), 403(b), or other employer-sponsored retirement plan.
4. Invest in Real Estate
If you don’t yet own your own home but would like to some day, now is the time to start working toward that goal. Having learned the lessons of the housing bubble, over the next few years, many potential homebuyers will be in a great position to take advantage of depressed housing prices and non-predatory loans. If you’re already a mortgage holder, paying off your mortgage principal early can help you save money in interest. Check with your mortgage lender to see what early payoff options are available under your loan terms.
SEE: Why Housing Market Bubbles Pop
5. Start a College Savings Fund
It’s never too early to start saving for your children’s tuition bills. The earlier you start, the less you’ll need to save, because compound interest and time will do much of the work for you. If you happen to save up four years’ worth of tuition early, you can always start putting your extra money towards college funds for books, computers and the like. A common tuition savings plan, called a section 529 plan, allows you to prepay qualified higher education expenses at eligible institutions. Not all 529 plans are the same, so you’ll want to do some research to see which would be the best fit for your family. Another option is a Coverdell Education Savings Account (ESA). This tax-deferred account will help you accelerate your savings.
The Bottom Line
While none of these options are as glamorous as purchasing a flat-screen TV, remodeling your kitchen or cruising to Hawaii, giving yourself the kind of financial security that lets you breathe easy even in times of crisis will provide you with a cool composure that never goes out of style.