So you’re getting a refund. And you’re imagining how you’ll celebrate: Fund your next vacation, maybe? Or buy a new spring wardrobe?
While it’s certainly okay to treat yourself, it’s a good idea to make the most of your tax refund — after all, it isn’t free money. “Don’t let the idea of a big check with no strings attached cloud your judgment,” says Kathleen Hastings, CFP, with FBB Capital Partners in Bethesda, Maryland. “It’s important to remember your short- and long-term financial goals.”
Next year, it may be a good idea to adjust your withholdings and keep the money in your own pocket. But this year, consider these five ways to make the most out of that chunk of change.
1. Pay Off Debt
This is probably a no-brainer, but if you have credit card or other consumer debt, use your tax refund to pay it down or pay it off. If you continue to carry debt, you prevent yourself from saving, investing, and meeting other financial goals, and you waste a lot of money paying interest.
2. Boost Your Emergency Savings Fund
As a rule of thumb, everyone should have an emergency fund stocked with about six months’ worth of expenses. For some people — those who are self-employed, freelancers, or workers in unstable industries, for instance — it can be wise to save even more. If your emergency account isn’t fully funded or could use more money, fatten it with your refund.
3. Max Out Your IRA
If you have an IRA and you haven’t contributed the maximum amount for the year, use your return to sock away more money. It’s a smart way to use your tax refund because you’ll be preparing for your future — and you won’t have to think about contributions for the rest of the year.
4. Start Investing
“The sooner you begin investing, the better off you are,” says Meg Muldoon, assistant vice president of advanced sales at Penn Mutual Life Insurance Company. “Using your tax refund could enable you to open an account and encourage you to allocate some funds each month to the account as well during the calendar year.”
If you’re new to investing, or just need help growing your money, Hastings recommends engaging a professional “planning partner” to help you prioritize, design, implement, and monitor your personal strategy for your future financial well-being. “Think of your planning partner like a personal trainer for your finances and to keep you motivated and on track with achieving your goals,” she says.
5. Invest in Your Business
If you own a business, and you’re on track with your personal financial goals, it may be a good idea to invest your tax return in your business. Maybe your business needs new equipment, inventory, or just some working capital.
Muldoon says some of the smart ways to use your refund to benefit your business include reducing business debt, enabling capital improvements, and establishing an employee benefit program. Using your own money to bootstrap your business means you won’t have to pay back a business loan or cede any control to business investors.
[Editor's note: This was originally published April 16, 2015.]