Be aware of tax preparers that are guaranteeing a certain refund amount upfront without fully knowing your tax situation. Yes, they can enter any information they want in order to increase your tax refund and gain your business, but here are a few things to know:
Below are my top 10 ways for spending your tax refund. I would suggest somehow spreading your refund across 3 or more of the categories below. I know there are countless ways to spend your tax refund so if you have any additional suggestions, please feel free to chime in under the comment section – I would love to hear your feedback!
1. Establish or Increase an Emergency Fund – If you do not have an emergency fund I would suggest establishing one with at least $1,000. With each additional year’s tax refund, add an additional $1,000 or more.
You can establish a savings account with your current bank, but you should also consider an online savings account if you have not. You will find that most online savings accounts offer interest rates at a much higher rate than brick and mortar banks. Ally Bank has an online savings account that I use and am pleased with.
On the other hand, there are online money market accounts that come with a checkbook and/or debit card. The interest rate with these accounts are slightly lower than the online savings accounts, but still much higher than interest rates at a brick and mortar bank. You ultimately get the best of both worlds with the high interest rate, along with quick and easy access to your money. I have personally used Ally’s online money market account which provides you with a free set of checks and debit card. Discover also offers an online money market account that provides free checks (no debit card). Just a word of caution, the Federal government limits the number of free withdrawals on money market accounts to 6 withdrawals per statement period. You are charged a fee per withdrawal after 6 withdrawals within a statement period.
2. Purchase Life Insurance – I know this may not seem like a “fun” way to spend your tax refund, but think about the future and the financial security you could provide for your family. Leaving a loved one with the burden of burial and any other of your financial expenses is not the way to go. Instead, use your tax refund to purchase a life insurance policy. I’m not suggesting that you purchase a million-dollar policy. Simply purchase a policy around $50,000 – $75,000, considering today the average cost of a burial is $7,000 - $10,000. Increasing the policy amount will allow for inflation, as well as well as any additional unexpected expenses your family may incur.
For the sake of this blog post, I entered some information online to get a quote to give you an idea of how inexpensive life insurance can be. For a female with average health, age 30, and a non-smoker an insurance policy of $660,000 costs $500/year. Spending $500 annually is minimal considering the average tax refund is $3,000, or more. Furthermore, your policy will probably be much cheaper if you opt of a policy lower than $660,000.
3. Pay Off/Down Debt (credit card, mortgage, student loans, car) – Pay down any debt that you may have. There are many options for choosing which debt to pay off first, but I would simply suggest paying off the one you are most comfortable with. For example, I have used the snowball method as suggested by many financial professionals. Under this method you will start with the lowest debt and pay that off first; you will then move on to the next lowest debt, and so on until you are debt free. Others may suggest starting with the highest interest rate and paying that debt off first. Again, it does not matter which method you choose, just simply pay off/down the debt.
4. Invest in a College Savings (529 Plan) for Your Child(ren) – There are two types of 529 Plans that you can invest in for your child’s future: (1) a prepaid tuition plan, or (2) a college savings plan.
The prepaid tuition plan allows you to lock in current tuition rates. This is beneficial considering the steady increase in tuition costs. Some prepaid tuition plans will also cover room & board and other qualified expenses.
The college savings plan does not lock in current tuition rates, but in turn covers all qualified costs including tuition, room & board, mandatory fees, books, and computers.
To read more about 529 Plans, you can visit the following link on the US Securities and Exchange Commission (SEC) website: https://www.sec.gov/investor/pubs/intro529.htm
5. Save for a Down Payment on a Home – Considering the average tax refund is $3,000, this is a great starting point to save for a down payment on a home. I personally know people that get back anywhere between $5,000 and $7,000 (this is an even better starting point).
What-if Scenario. With the average tax refund being $3,000, within 3 years a person could have a savings of $9,000 plus any earned interest. Federal Housing Administration (FHA) Loans are popular today because of the lower down payment option of 3.5%. If a person went the route of an FHA loan on a $100,000 mortgage, the minimum down payment would be $3,500 and would leave the person with approximately $5,500 for closing cost (if not paid by the seller), updates to the home, or new furniture and decor.
I’d like to note there are a few other things to consider before jumping into the home buying process, and the scenario noted above is for one that has the appropriate credit score to get approved and a clear understanding of the cost of homeownership. For example, you will now be responsible for homeowner’s insurance, property taxes, indoor/outdoor maintenance, and run the risk of being liable for anyone getting injured on your property (that isn’t already covered by your homeowner’s insurance).
6. Renovate Your Home – Start making those updates to your home that you’ve been wanting. If you make updates that are not overly personalized, you should be able to add value to your home at the same time. Here is a list of budget friendly updates that can add value at the same time:
7. Save for the Business You Have Been Dreaming Of – Here’s another great reason to save. Become your own boss! The logic is like saving for a home; instead, save for 5 years. After 5 years of saving $3,000 each year, you will have accumulated $15,000 ($30,000 if your average refund is around $6,000) to start up that business you have always wanted.
Depending on the type of business you want to start, you may be able to start up the business using only one-years’ worth of tax refund money. The service industry typically has low start-up costs and examples include blogging/vlogging, lawn care, bookkeeping, home and office cleaning services, personal shopper/stylist, financial counselor, specialized tutor, computer technician, and window installer. The costliest expenses in the service industry are your time and expertise; all other expenses are typically administrative and minimal.
8. Establish a Christmas Fund – This an annual expense for some people, especially those with young children. Also, many people are recuperating from the holiday shopping around the time you receive an income tax refund. It is wise to go ahead and plan for the next holiday season by setting aside $500 – $2000 for shopping depending on the average dollar amount you typically spend each Christmas.
Many credit unions still offer a ‘Christmas Club’ savings account. If you aren’t a member of a local credit union, you can always open an online savings account (as mentioned above for the Emergency Fund) and hold those funds in the account until Christmas.
9. Charitable Donation (give back to the community) – Find a local non-profit group that interests you and make a monetary donation or purchase an item that the organization or your community needs. Although you will not receive an immediate financial benefit, you can write the donation off on your income tax return for the next year.
My key reason for adding this to list is because of the societal benefit and the internal pleasure and meaning that it brings to your life. I have a charity that I donate to regularly in Northeast Louisiana because the work that they do holds a special place in my heart. If you do not have a charity in mind that you would like to donate to, please feel free to email or message me on social media and I will give you the information to the charity that I donate to.
10. Have Fun! Prepay a Vacation! – ONLY DO SO IF YOU HAVE ALREADY ESTABLISHED AN EMERGENCY FUND AND PURCHASED LIFE INSURANCE! I repeat, ONLY DO SO IF YOU HAVE ALREADY ESTABLISHED AN EMERGENCY FUND AND PURCHASED LIFE INSURANCE! (I can’t stress this enough). I would also suggest only spending no more than 20% of your tax refund on a vacation. One cheap cost-friendly vacation that I enjoy is going on a cruise. You can typically find 3-5 day cruises for $300 - $700 per person depending on the port location. Food and some entertainment & beverages are included in the cruise price. When visiting the port cities there are many beaches that you can visit for free and other areas around the port that you can sightsee for free.
I am a personal and small business finance enthusiast with a deep interest in making people's lives a little easier with financial tips and advice.