It may not exactly be like winning the lottery, but getting a tax refund can make you feel like you’ve hit the jackpot. However, rather than splurging on a high-ticket item you most likely don’t need, there are other ways to make the most of your filing your taxes. Here are a few great ways to invest your tax refund that—with commitment and patience—will benefit you in the long term.
Pay off debt
Especially if it’s high-interest debt. There’s no bigger worry for many Americans than credit card or loan debt with compounding interest. It often feels like there’s no end in sight.
If your tax refund is enough to pay off an outstanding balance on a credit card, do. If you pay off $2,000 in high-interest debt, for example, you could save $3,585 in interest. If you have more than one high-interest credit card, implement the “avalanche” approach to your debt payment plan. With this method, you’ll pay off credit cards with the highest interest first, thereby saving you hundreds, even thousands, of dollars in unnecessary interest.
Start an emergency fund
According to the Consumer Financial Protection Bureau, a quarter of Americans don’t have emergency savings to cover short-term financial hardships. With a possible recession and rising inflation, starting an emergency fund—using a high-yield savings or investment account—sets aside cash that can come in handy when the unexpected happens.
America Saves, a nonprofit arm of the Consumer Federation of America, recommends the “past-present-future” method, which allocates 30% of your refund to reduce debt, 40% for current needs and emergencies, and 30% to your future. For an emergency fund, however, the standard rule of thumb is having at least three months’ worth of income available.
Invest your tax return
One way to build wealth that lasts is by investing your tax refund. Let that money—and the money from future tax returns—grow and put yourself on the road to financial independence.
Consider this example from the experts at Nerd Wallet: If you receive a $3,000 refund and invest it over the next 10 years (earning a 6% average annualized return), you’ll have more than $5,000 in that investment account. Better yet, if you invest $3,000 from your refund each of those 10 years, you’ll have more than $40,000 thanks to compounding and earnings.
If you’re a minimal risk taker, an EFT (exchange-traded fund) or index fund are sound options. Both spread out risk across different stocks that track a particular index, like the S&P 500. If you’re more of a risk taker, you could invest directly in the stock market through a brokerage firm.
Contribute to an IRA
An individual retirement account (IRA) is a powerful way to save for your retirement tax-free. Managed by you, rather than an employer, the account accrues interest on the money you contribute.
If you’re eligible to contribute to an IRA, be aware of the contribution limits. For 2023, you can contribute $6,500 or $7,500 if you’re age 50 or older. An IRA contribution can help you boost your retirement funds and may be a good option if you have sufficient emergency savings, don’t have credit card debt at a high APR, and have maximized your 401(k) contributions.
Focus on your health
If you have a health savings account (HSA) or flexible spending account (FSA), consider using your tax check to fund these accounts. Both accounts are designed to cover health-related costs and have significant tax benefits. An HSA is triple tax-free in that your contributions, earnings and withdrawals aren’t taxed, while an FSA is tax-free for qualifying medical expenses.
There are contribution limits on these accounts. For 2023, the maximum for an HSA is $3,850 for an individual and $7,750 for a family. The limit for an FSA is $3,050.
Invest in yourself
No matter if you work for yourself or for someone else, you are your most valuable asset. To ensure your marketability, use your tax refund to pay for such things as continuing education and training, work-related conferences and memberships to professional organizations in your industry. These investments can pay off in the form of a higher salary and greater job stability.
Pay it forward
While supporting a cause you care about can make a difference in other people’s lives, it can also provide you with a potential deduction for next year’s taxes.