Anticipating a tax refund? Before you blow it on something frivolous, consider these five ideas on how you might better use it.
Getting a tax refund? You’re not alone.
Last year, the Internal Revenue Service (IRS) issued more than 126 million tax refunds to 74% of filers, with the average check amounting to $2,549. We won’t get into the debate about the pros and cons of receiving tax refunds. Instead, let’s look at some savvy ways to handle that windfall.
Here are five things you could do with your tax refund:
You’re probably wondering, “When will I get my tax refund?” The IRS estimated that nine of 10 taxpayers will get their refund via direct deposit within 21 days of filing electronically if there aren’t any issues with their tax return.
That gives you plenty of time to decide where to put the money. Planning what to do with the funds means you’ll be more thoughtful and intentional with that cash. Otherwise, it could easily be siphoned off and disappear.
Dara Luber, senior manager of retirement at TD Ameritrade, suggested looking at a tax refund in the context of household budgeting and a “three-bucket system” of saving, spending, and charity. Your budgeting may have changed significantly over the last year because of the pandemic. Some people lost jobs and may not have as much income, while others may have saved money by not commuting or paying for childcare.
Despite an individual’s circumstances, the three-bucket system still works—it just may need to be tweaked.
The savings bucket can be earmarked several ways. For people who are just getting back on their feet financially, you might consider starting or replenishing an emergency fund.
A portion can be devoted to a major purchase, such as saving for a new home or car. Some of it can go to retirement savings or toward a child’s 529 plan. Those last two may also be tax write-offs, especially if the retirement money goes into a traditional individual retirement account. Getting a potential tax write-off already puts you ahead for next year.
Speaking of tax write-offs, in 2020 Congress allowed people who donated up to $300 in cash to an eligible charity (not stock) to take an above-the-line write-off. In 2021, Congress doubled that amount to $600.
Given how many charities were hurt during the pandemic, and the greater need some people had to tap them, donating cash to charities is a way to consider giving back. Some employers also make matching charitable contributions, so that’s a way to double your impact.
When it comes to other charitable donations, such as securities and donor-advised funds, remember the IRS has a list of rules, limits, and qualifications. If you’re unsure, consider talking to a financial or tax advisor for more detail.
If you have some outstanding debt, especially something like high-interest credit-card debt, consider wiping the slate clean and using the tax refund to reduce or retire that debt. A tax refund can also be used to apply an extra mortgage payment to your home loan without busting your monthly budget. People who can make an extra payment once a year on their mortgage on 30-year loan may cut as much as four to five years off the life of the loan, depending on interest rates.
If you own your own home, you might consider using your refund for home improvements. During the pandemic, many people decided to give their homes a facelift because they weren’t going on vacation and wanted to use money where they were spending most of their time. Whether you’re a DIY home improver or want to hire someone to do a bigger remodel, earmarking your refund for upgrading your dwelling is another choice. Some inexpensive ideas might include refinishing kitchen cabinet doors, installing higher-end bathroom fixtures, or improving curb appeal. However, because home improvement has been a popular pandemic project, some durable goods may be in short supply or contractors may be busy.
There are a couple ways to look at this. Work-related classes can play a role in your career. Look for classes that can help you increase your earning potential, especially for millennials and Gen Z—but even for Gen X, who still have a good decade or more to go before retirement. Depending on how you file, work-related education may be eligible for a tax write-off.
Not all investments in yourself need to be work related. You could take a class that improves another part of your life. Fitness classes, cooking classes, art workshops, and spiritual retreats are all ways to pursue self-improvement.
Strengthen bonds that have nothing to do with fixed income. Consider memory-building experiences with friends or family. “A retreat that you and your spouse would like to attend together could help strengthen your foundation as a family,” Caballero observed.
Listen, we get it. We’re all drawn by the bling. But don’t let that shiny, bright object consume your whole refund, or worse, actually put you in debt. It’s completely fine and even healthy to treat yourself. But don’t go overboard. It’s like when you were a kid and a parent said you had to finish your veggies before you got dessert.
Once you’ve taken care of the necessities—including saving for the future—it’s okay to indulge in a bit of travel, some new shoes, or whatever feeds your “sweet tooth.”
But before you buy on impulse, ask yourself if you really need the item or whether it will help you get to where you want to be.
The key to filing taxes is being prepared. TD Ameritrade provides information and resources to help you navigate tax season.
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