Smart Things To Do With Your Income Tax Refund

Posted by Craig Brokowski on April 12, 2010 in Personal Finance

The following post is from Craig, the creator of Free from Broke – A personal finance blog for regular folks.

You’re getting an income tax refund this year! According to the IRS, the average tax refund is $2,488. Sure, you know you should probably try to adjust your tax withholding so you don’t get a refund, but you got one this year anyway. So what should you do with it?

Smart things to do with your tax refund:

1. Pay Off Credit Cards – Are you carrying a credit card balance? Here’s your chance to eliminate or reduce it before you accrue any more interest charges!

2. Build Your Emergency Fund – How big is your emergency savings? Will it cover 6-12 months of expenses should something happen to your income? If your emergency fund isn’t large enough consider using your tax refund to fund it. A great place to put an emergency fund is into an online account with a high yield or by building up a CD ladder.

3. Individual Retirement Account (IRA) – Is your IRA fully funded? The 2010 limit for IRA funding is $5,000 (this gets phased out depending on your adjusted gross income). If the average refund is about $2,500 then you can fund about half of your yearly IRA limit with your tax refund. Get a head start on saving for your future!

4. 529 Plan – Have kids? Help them have enough for college by investing in a 529 plan. Not only are these plans deductible on your Federal return, but some states allow a deduction as well.

5. Financial Goals – Use your tax refund to jump start your financial goals. This could be anything from building up a down-payment for a house to saving up for a new car.

6. Raise Your 401(k) Investment – You can either raise the amount taken out of your paycheck for your 401(k) one time so it matches your refund or adjust each paycheck to match your refund for the year (divide your refund by your remaining paychecks, this is the amount to aim for). You get the extra bonus of your 401(k) contributions lowering your taxable wages.

7. Pre-Pay Your Mortgage – A one-time pre-payment of $2,500 could potentially save you many more thousands over the life of your mortgage. Pre-paying your mortgage provides a nice return over the long run.

8. Pay Off/Pre-Pay Student Loans – If you have high interest student loans (usually private loans) then you may want to consider using your tax refund to pay off or pre-pay your loans.

9. Pay Off Car Loan - Pay off all or at least some of your car loan. Make sure your payments go towards the principal amount.

10. Go to School – Take a course that can help you in your professional career. Or if you haven’t finished your degree, go back and take courses toward your diploma. Statistically, college graduates make much more than non-graduates over their working careers. Higher degrees have the potential for more.

11. Start a Small Business – A tax refund could be just the opportunity to start up a small business. There are many ways a person can make extra money with a small business that doesn’t need exorbitant start-up costs.

12. Upgrade Your Work Wardrobe – Want to get ahead at your job? Sometimes looking the part can go a long ways to getting noticed by your superiors. Your tax refund could be just what you need to upgrade a few key pieces of your work wardrobe.

13. Spend It – Yes, I said it. Spend your tax refund. If your financial house is in order and your goals are being met then consider spending your refund on you and your family. Go for a great experience like traveling abroad to a city you have never seen before or doing an activity you have never tried.

This year we actually got a nice-sized refund back. We certainly didn’t intend to but my wife went back to work while I am staying home with the kids now. We also added to our family (a beautiful little princess of a tax deduction).

So what are we doing with our refund? We’re banking it for now. We just started looking for a house the the refund will do nicely to help defray closing costs (that’s step 5 – Financial Goals).

A tax refund is a nice windfall to have and clearly there are plenty of ways you can use it. So, tell us: How do you plan to use yours?