Smartest Ways to Spend Your Tax Refund

March 01, 2016 : Laura Adams – Guest Contributor

According to the IRS, almost 80% of taxpayers get a federal income tax refund—and the average amount is around $2,800. That’s a big chunk of change! Before you spend it on a shopping spree or booking a cruise, consider how it could improve your personal finances instead.

Saving might not be as much fun, but it can be the key to creating long-term financial security. Here are five tips for the smartest ways to spend your tax refund.

Tip #1: Build your emergency fund 

One of the best financial safety nets you can create is a cushy emergency fund. It can get you out of tight spots, such as losing your job, needing an unexpected car repair, or getting a large medical expense that your insurance doesn’t fully cover.

A good rule of thumb is to keep at least three to six months’ worth of your living expenses in an FDIC-insured savings account. If you don’t have that much in reserve, make sure building your emergency fund is a top priority for your tax refund.

Tip #2: Buy insurance

Having enough of the right kinds of insurance is important for keeping you and your family safe. If you don’t have key policies, consider using your tax refund to pay premiums.

The Affordable Care Act requires most individuals not covered by an employer’s plan, Medicaid, Medicare, or other public program to purchase health insurance or pay a penalty.

If you have a spouse, children or others who depend on your income, it’s ideal to also have ample life and disability policies. Life insurance pays one or more of your named beneficiaries a lump sum if you die. And disability pays a percentage of your monthly income if you get sick or injured and can’t work.

Tip #3: Fund a retirement account

Investing through a tax-advantaged retirement account is a smart way to create future financial security. If you have a 401k, 403b or 457 plan at work, increase your payroll contribution and use your tax refund to make up any shortfall in your budget.

You could use a refund to build or start an IRA. If you’re also covered by an employer’s retirement plan, your tax deduction for a traditional IRA depends on how much you earn and your tax filing status.

Remember that there may be tax penalties for withdrawing money from a retirement account before the age of 59½. So be sure to put money in an IRA only after you’ve established an emergency fund and are sure you won’t need the money.

See also: A 5-Day Plan to Improve Your Personal Finances

Tip #4: Pay down high-interest debt

If you have a healthy emergency fund, but also have expensive debt—like high-interest credit cards, retail store cards or payday loans—use your tax refund to pay them down.

Reducing or eliminating debt cuts your monthly interest payments so you can save more money.

Tip #5: Fund a college savings account 

If you’re saving money for your own education or for your children’s education, consider putting your tax refund in a 529 savings plan. Funds in a 529 grow completely tax-free if you spend them on qualified education expenses such as tuition, books and computer equipment.

Getting Your Tax Refund

Want to directly deposit your tax refund into multiple accounts, such as a bank savings and an IRA? No problem. Just submit IRS Form 8888 with your tax return.

If you get a big tax refund year after year, you may need to adjust your withholding so less tax is deducted from your paychecks. Use the Tax Withholding Calculator for help completing a new Form W-4 and submit it to your employer.

Start filing for free online with H&R Block.

Related Topics

Avatar

Laura Adams – Guest Contributor

Laura Adams is a personal finance expert, author, and consumer advocate. She hosts the popular "Money Girl Podcast," which has been downloaded over 40 million times by legions of loyal fans.

Related Resources

IRS Letter 1830 – Notice of Final Partnership Administrative Adjustment

Learn more about letter 1830 and how to handle an adjustment to your partnership's return with help from the tax experts at H&R Block.

Verify Deposited Tax Return

Learn how to verify if your tax return has been deposited in your bank account with advice from the tax experts at H&R Block.

Fix These Tax Problems Before the New Year…

As the year ends, take steps to prevent tax problems in the new year. Don't let IRS issues get the best of you - learn how to fight them at H&R Block.

Getting Your IRS Tax Refund Status

Find out how to check your IRS refund status and what you need to get your tax return. H&R Block is here to help you get your tax refund.