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Make the Most of Your Tax Refund: Smart Strategies for Financial Success
Are you letting your biggest financial windfall of the year slip through your fingers?
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Hey there! One thing I always look forward to when spring rolls around is my tax refund. About 65% of American taxpayers receive a federal tax refund, and get this – the average refund for 2023 was a whopping $3,167! That's some serious cash. Today, I'm sharing some advice from financial pros on how to make the most of this money instead of watching it disappear on random stuff (been there, done that).
What We'll Cover
Paying Off High-Interest Debt
What's the first thing you should consider when that refund hits your bank account? Most financial experts agree on one thing: tackling your high-interest debt.
"It's an immediate return on investment by reducing interest costs and improving financial stability while also providing peace of mind and a sense of relief from financial stress," said Sam Swift, a certified financial planner and CEO of TCI Wealth Advisors in Tucson, Arizona.
Think about it. Credit cards can carry interest rates of 22% or higher. And payday loans or auto title loans? Those rates can be straight-up criminal. Michael Sullivan, a personal finance consultant at Take Charge America, a credit-counseling and debt-management company in Phoenix, emphasizes that these high-interest debts should be your top priority.
The benefit of paying off high-interest debt is immediate. For example, if you pay off $1,000 in credit card debt with a 22% interest rate, you're saving $220 in interest per year. That's an after-tax return that beats most investments by a mile!
Building Your Emergency Fund
What's next after you've tackled (or if you don't have) high-interest debt? Creating or adding to your emergency fund is a smart move. According to a February survey by Bankrate.com, nearly half of Americans are stressed about this area. About 13% of respondents have no emergency savings whatsoever, while another 33% have some savings but higher credit card balances.
Sullivan considers $1,000 the absolute minimum target you should aim for.
"If there is less than $1,000, it's not an emergency fund at all because even one accident or illness with a trip to the emergency room can easily cost more than $1,000. Without adequate savings, emergencies turn into high-interest debt." - Michael Sullivan
Steven Conners of Conners Wealth Management in Scottsdale thinks emergency funds are more important now than in recent years because of all the turmoil and uncertainty in the economy – tariffs, ongoing layoffs of federal workers, you name it. He suggests, "Be more conservative than you'd normally be."
Most financial advisors recommend saving enough to cover 3-6 months of essential expenses in your emergency fund. But if that feels overwhelming, start with that $1,000 minimum and build from there. Look for accounts yielding at least 4% - you can find these rates on money market mutual funds and some bank and credit union vehicles, especially if you ask for better deals.
Investing in Retirement Accounts
Once you've got your short-term needs covered with an emergency fund and you're chipping away at credit card debt, you can focus on longer-term goals. Retirement accounts like Individual Retirement Accounts (IRAs) or 401(k)-style plans fit the bill, providing tax incentives to boot.
With traditional IRAs or 401(k) plans, you can generally reduce your taxable income by the amount of your contributions. With Roth versions of these accounts, you don't get a front-end benefit, but the money comes out tax-free years later when you withdraw it. So, you're sacrificing some near-term tax help for benefits down the road.
"Even small contributions can grow significantly over time, helping you build wealth tax-free for your future," said Swift.
If your employer offers matching funds on contributions to a 401(k) account, you can stretch your tax refund even further. "Always at least contribute up to the amount your company is matching — it's free money," Swift advises.
For 2024, the maximum IRA contribution limit is $7,000 annually ($8,000 if you're 50 or older), while 401(k) accounts allow up to $23,000 ($30,500 for those 50+).
Adjusting Your Tax Withholding
Here's another thing to consider about tax refunds. If you're getting a large amount, Sullivan suggests changing your withholding percentage by filling out a new W-4 form through your HR department. Why do this? Because refunds represent money that you essentially have loaned, interest-free, to the Internal Revenue Service and perhaps a state tax agency.
To complete the picture, he suggests taking the dollar amount by which your future paychecks increase through lowered withholding, then depositing that money automatically into a high-interest savings account. It's a move that essentially spreads out your refund, gives it to you earlier, and allows you to earn interest sooner. But the strategy would backfire if you spend, rather than save, the incremental amounts.
If you adjust your withholding too much, you might end up owing taxes at the end of the year. Don't overdo it - find a balance based on your refund patterns from the past few years.
Strategies for Smarter Spending
Excessive spending is the root of the problem for most anyone with high debts or low savings. Solving this issue requires discipline, which isn't easy.
But there are ways to add guardrails, such as delaying certain purchases to wring some emotions out of the decision. If there's something you really want to buy like new golf clubs, consider a cooling-off period of perhaps a week or 10 days, Connors suggested. Chances are, you'll abandon certain purchases. But if you really want to buy something after that time, "You will at least know your emotions are less involved," he said.
Many financial experts think a small reward for yourself can be helpful. But try to limit it to about 10-20% of your total refund.
For example, if you get a $3,000 refund, use $2,400-$2,700 for debt repayment or savings, and the remaining $300-$600 for a small gift to yourself or an experience. This way, you're making financial progress without giving up all enjoyment.
Your tax refund offers a significant opportunity for financial stability and future security. Prioritizing high-interest debt repayment, building an emergency fund, and investing for retirement are smart ways to use your tax refund. You can also adjust your withholding to receive money more regularly and earn interest. Finally, implementing a cooling-off period for purchases is crucial to remove emotion from spending decisions.
How are you planning to use your tax refund this year? Share your thoughts in the comments below!
[1] Source: USA TODAY, "Maximize your tax refund: Smart strategies for financial success" by Russ Wiles