The US government sends out billions of dollars in tax refunds each year, and the average return last year was about $2,775. So if Uncle Sam hands you some cash back, what’s the best thing to do with it?
Tax refund move #1: Get covered for emergencies.
As kids, we were all taught to call 911 when disaster strikes. But in the case of a financial emergency, your local switchboard operators probably can’t help you. That’s why having an emergency fund is a big step toward financial freedom.
We recommend starting out by building up a cushion of about one month’s take-home pay as soon as you can. So if you’re not there yet, stash some of that tax refund away in an easily accessible savings account. This is “life happens” money, and it needs to be on hand immediately if and when (hopefully if) you need it.
Eventually, once you’re free of high-interest debt (see tax refund move #2), you can come back and finish funding that rainy day fund. A good guideline is to ultimately aim to keep three to six months’ worth of take-home pay in there. (Here’s some more advice about emergency funds, if you’re looking.)
Tax refund move #2: Pay down that credit card debt.
We recommend paying off your high-interest (which usually means “credit card”) debt, if you have it, before you invest. That’s because high-interest credit card payments are likely to eat away at any investment returns (or cancel them out altogether). Your goal with any money move is to make progress, not tread water. So if you have that mini emergency fund in place, use those extra tax dollars to put an additional dent in that credit card debt next.
Here’s our best advice for creating your debt plan of attack.
Tax refund move #3: Put those tax dollars to work
If you’ve already worked hard to build emergency savings and pay down your credit cards, congrats! You’re on fire.
Now you have a choice: You could either let that refund sit in the bank and earn little to no interest, or you could put it to work for you and your most important goals — creating the retirement you’ve been daydreaming about, launching that genius business idea, getting to a down payment on the house with the pool/outdoor kitchen/majestic views/room for kids/all of the above. (Which choice do you think Future You will thank you for?)
We think one of the smartest money moves you can make is to invest regularly — a bit out of each paycheck — into a low-cost, well-diversified investment portfolio. If you’re just getting started, you can open your account, use your extra tax money to make a big-time contribution to your plan, and then set up smaller, automatic contributions going forward.
If you’re an Ellevest member, you can even have your tax refund deposited directly into your investment account. Just give your account’s direct deposit information to the government when they ask you where they should send your money (just like you’d give that info to your payroll provider if you were setting up regular paycheck deposits).
So that’s our advice: Build your emergency fund, pay off credit card debt, and then invest in your goals. Hear that? It’s the sound of Future You asking for a high five.
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