The average tax refund for 2016 is estimated to be $2,900. While it might be tempting to use this windfall for something fun, like a vacation to someplace warm and exotic, there are better ways to spend your refund that can help improve your finances for years to come. Yes, you can call me a kill-joy, but delaying gratification can have its rewards in bigger and better ways, like being able to buy your dream home sooner than expected, or being able to take that once in a lifetime vacation that you never thought you would be able to afford, or retiring early. Laying a solid foundation first will enable you to then focus on the perks in life. So, before you call your travel agent and book a trip to Cancun consider these three less exciting, but more rewarding ways to spend your tax refund (if you’re not getting a tax refund, look to address these items as you get some spare cash):
- Get Rid of Credit Card Debt. Even if your bill is bigger than your refund, it pays to get rid of as much debt as quickly as possible. If your card charges 18% interest and you pay off all or some of that debt, it is the same as if you earned 18% on your money. Remember to see which cards carry the highest rates. Pay those off first and stop using all cards. If you absolutely must charge, make sure you use a card carrying the lowest rates.
- Add to Your Emergency Fund. It is recommended that you have six months’ worth of income stashed away in a liquid account (bank account, money market, etc.) in case of illness, or unemployment. In the event of an emergency, how long could you go on paying your bills? If your account seems thin, beef it up.
- Fund Your Investment Accounts. As part of your monthly budget, it is recommended that 10% of your take home pay goes towards savings. In addition to adding to your emergency fund and other general savings, this 10% can be satisfied in a number of ways:
- Fund retirement through an employer-sponsored plan. This has enormous benefits, because the investment often times can be made with pre-tax dollars (lowering your income taxes) and the investment can grow without the effect of taxes, provided you withdraw the money in retirement. Also, many employers help you save toward retirement by matching a percentage of your contributions. That is called free money – and it’s hard to find.
- Fund an IRA or a Roth IRA (contributions can be made for non-working spouses). Again, tax-deferred growth is a key benefit here. Check with your tax advisor if you qualify for a Roth IRA, as it has unique benefits such as tax-free withdrawals, and the ability to withdraw for reasons other than retirement, such a first-time home purchase, or to meet college costs. Contribution limits are $5,000 ($6,000 if you are at least 50 years old). Contributions for 2016 can be made until April 15, 2017 (for both IRAs and Roth IRAs).
- Add to your child’s college savings. Whether you open a specific college savings account, such as a Coverdell account or a 529 Plan, or opt for a more general account, such a mutual fund or savings bond, you can take an important step in securing your child’s future.
If it makes it easier to get started, think of it this way: you wouldn’t give your kids dessert before they had dinner. This list is dinner, and there’s no telling what kinds of dessert await you if you take care of this very necessary business first.