Getting a tax refund can be a big financial win — but only if you use it correctly.
The first time I received a tax refund, I was thrilled. I also wasn’t really sure what to do with it. I had just completed a master's program and had a shiny new degree along with a nauseating amount of debt. For a brief moment, I thought about booking a vacation I’d been dying to go on.
What better way to use that money than to treat myself, right?
Ultimately, I took that money and paid down my debt. The decision was less exciting at the moment, but it had the best return on investment.
And now that my student loans are a thing of the past, I’m thankful that I knew what to do with a tax refund.
If you receive a tax refund, it’s important to use it wisely. But before we discuss how to use it wisely, let’s explore what a tax refund is and how to get the best tax refund in the first place.
What Is A Tax Refund?
The IRS requires that every citizen makes regular tax payments throughout the year, which are either withheld from our paycheck or made through quarterly estimated tax payments.
If you overpay in taxes through the year, the IRS will send you a refund.
According to IRS data, by the end of the 2019 tax season, there were over 100 million tax refunds issued and the average refund amount was $2,729.
For many taxpayers, that welcome surprise leaves them wondering what to do with a tax refund.
How To Get The Best Tax Refund
Because a tax refund comes from giving the IRS too much of your money to begin with, it’s best to not overpay your taxes during the year. After all, would you give anyone else an interest-free loan?
It’s important to ensure that you’re not overpaying for your taxes throughout the year.
When it’s tax season and you’re ready to file your tax return, you’ll want to make sure you claim all of the money you legally can.
Here are a few things that can help you do this.
Itemize Your Deductions
The 2017 Tax Cuts and Jobs Act nearly doubled the standard deduction, which means itemizing deductions won’t make sense for most taxpayers.
If you don’t know, itemizing means that you deduct taxable expenses, which will decrease your taxable income. Itemized deductions include state and local income taxes, property taxes, mortgage interest, medical or dental expenses, and charitable contributions.
In most cases — but not all — the standard deduction will provide more of a tax benefit that itemizing your deductions. Still, before you opt for the standard deduction, add your itemized deductions to see if they’d earn you a bigger tax break.
While deductions reduce the amount of taxable income you have, tax credits directly subtract from the amount of tax that you owe, making them valuable in lowering your tax bill.
Contribute To Your Retirement
One of the easiest ways to lower your taxable income is to make a contribution to an eligible retirement account. The more money that you put into an employer-sponsored 401k, the more that you can reduce from your taxable income. This is the same case with an IRA.
10 Things To Do With A Tax Refund
Now that you know what a tax refund is and how to ensure that you’re receiving the best tax refund possible, here are 10 things to do with it.
Replenish, Boost, or Create an Emergency Fund
We recommend saving 3-6 months worth of expenses in an emergency fund. The goal of this fund is to pay any unforeseen medical bills, auto repair, and unemployment.
If you don’t have that much saved, putting money towards building that emergency fund is exactly what to do with a tax refund.
More importantly, it should be your first step.
Pay Off High-Interest Debt
Another thing to do if you’re wondering what to do with a tax refund is to pay off high-interest debt. High-interest debt isn’t just a personal burden — it’s a nationwide epidemic.
The average American household that carries a balance on their credit card from month to month has $9,333 in credit card debt.
That’s not to mention the average interest rate, which is currently over 17%,
By using your tax return to pay off some or all of your high-interest debt, you’re giving yourself a monthly gift of not having to pay sky-high interest.
Contribute To Your Retirement
Want to do something that future you will thank you for? Be wise and put your refund towards your retirement.
Not only will you feel good knowing that you’ve put away the money (gaining interest) to fund your golden years, but some of your retirement contributions will also earn you a tax deduction, helping you get another tax refund next year.
Invest In Your Business
If you own your own business, it might be the time to make an investment in your business that you’ve been putting off.
Spend more on your marketing, giving your website a facelift, or put money towards that conference you’ve wanted to attend.
Invest In Your Education
The best return on investment is investing in your education. This could range from learning how to start your own side hustle or taking online classes in to increase your financial literacy. If you’re interested in the latter, you can watch our Wealth Building 101 for free here.
Save For Your Child’s Future
Unless your children get significant scholarships, school tuition can be a backbreaking expense. Make a dent towards saving for college by setting some of your tax refund aside for them.
Make Home Improvements
If you’re a homeowner you likely have a running list of things you’d like to improve around your home.
Why not use the refund to make some of your home improvements and increase the value of your home?
(Learn 12 High-ROI Home Improvements That Maximize Your Property Value by clicking here.)
Not only can improvements increase the value of your home, some will also save you money from month to month, such as solar panels and smart thermostats.
Make a Charitable Contribution
If there is a charity that is near and dear to your heart, consider making them the lucky recipient of your cash refund windfall. Not only will you feel good about where your money is going, but you may be able to use the donation as a tax deduction.
Spend It To Save
There is probably a long list of little things that you could think to spend your tax refund on. Why not look for things that will make your day-to-day life better, and save you money in the long-run?
That might mean buying yourself a nice coffee maker so you can finally ditch your expensive coffee shop habits. Or buying yourself some weights so you can cancel your gym membership (that, to be honest, you don’t actually use).
Explore ways that you could actually be saving money, and use your tax refund as fuel for this savings process.
Save For an Exciting Goal
What are some of the big goals that you have, that you may not have been able to save for yet? Maybe it’s getting a start on buying a home. Use your tax refund to give those goals a boost.
5 Things NOT To Do With A Tax Refund
While there is an endless list of what to do with a tax refund, there’s also a big list of what not to do with a tax refund.
Let It Sit in Your (Interest-Free) Checking Account
If you aren’t sure what to do with your money — this is taking into account that you already have an emergency fund in an easy to access checking or savings account — you might put it in a bank account and not think about it further. This is a bad idea for two reasons:
You’re earning NO interest on that money. Even if it’s in a savings account, you’re still getting a ridiculously small amount of interest. Because you may not need that money in the near future, it’s a better idea to put it somewhere where you can get a real return (try investing).
Money sitting in an easily accessible checking account has a sneaky way of being spent. Don’t spend the extra money slowly until you realize it’s all gone months later. By investing it, you can make your money work for you, and you won’t be tempted to spend it.
Go On A Shopping Spree
If you’re wondering what to do with a tax refund, here’s what not to do: blow it on a shopping spree. It’s tempting to treat yourself. You’ve worked hard, so you deserve it, right?
What you actually deserve financial freedom and a life of true wealth: an abundance of time, money and influence.
Rather than blowing your money on an afternoon shopping spree at the mall, put it towards investing in something that will build this long-lasting wealth.
If you really want to treat yourself, set aside a small percentage to buy yourself something you’ve been eyeing. Then make a smart decision with the rest.
Buy An Expensive Car
There’s nothing wrong with buying a car that you need. But using your refund as a down payment to buy a car you can’t afford with your typical income is a bad idea that will wind up being a money pit.
Say no to that luxury car and buy something that fits your budget. Your financial future will thank you.
Play The Lottery
Sure, a tax refund feels like free money. So why not double down on your luck and see if you can make more by playing the lottery or gambling?
Let’s be honest: the odds are stacked against you. With most lotteries, the odds of you winning are 1 in 13,983,816. With the lottery, you’re essentially giving away your money. Except for this time, it isn’t even for a charitable cause that you can receive a tax break from. Do yourself a favor and stay away from this wasteful spending.
Spend All Of It On Your Kids
I know, I know. Your kids are cute, sweet, and in desperate need of something, such as a new bicycle. If they’re older, maybe it’s a new phone or a new car.
While sometimes it feels great to splurge a little and be their favorite person for the day, don’t use your tax refund as an excuse to buy them all the things they want, things that will depreciate over time.
While it’s ok to purchase toys and other items for your kids, don’t completely blow this sudden cash on things that won’t last.
Don’t Rely On a Tax Refund For Your Financial Needs
While getting a tax refund may be a welcome surprise during tax season, don’t let it become something that you rely on financially.
If you rack up credit card debt or buy things you can’t afford because you expect a tax refund is coming your way, you are setting yourself up for financial struggle and stress if you don’t receive it.
The bottom line of what to do with a tax refund is this: treat a tax refund as an unexpected opportunity to make an investment that will pay off for years to come.
Erica Gellerman is a CPA, MBA, personal finance writer, and founder of The Worth Project.