Filing taxes isn't fun, but receiving a tax refund can be. In 2021, over 100 million refunds were processed and refunds averaged $2,873 -- and unless you need the money to immediately pay rent or bills, it's a good idea to plan ahead for how best to use the funds.
While it may be tempting to spend your money right away, consider using all or a portion of it to enhance your finances. Here are several smart ways you can put this money to good use for yourself and your future.
1. Pay down debt
Whether it's credit cards, student loans, buy-now-pay-later services or medical bills, living with debt can be all-consuming. While your tax refund may not be large enough to wipe these balances clean, you can use it to make a dent in your debt -- specifically high-interest compounding debt.
Credit cards tend to be the debt with the highest interest rates -- though this isn't always the case. Paying down the debt with the highest interest rate first (aka the avalanche method) can help you save money down the road in interest charges. Plus, with the Fed expected to raise rates as early as March, credit card interest rates are also expected to rise.
If you have multiple credit cards with similar APRs carrying debt, you could also opt to pay down the smallest balances first (the snowball method) so you have fewer remaining credit cards to worry about paying off.
"Tackling the card with the lowest balance first can be a quick win and give us the mental strength to pay down the remaining balances. It's an initial confidence booster that can go a long way towards becoming debt free," says CNET Money Editor at Large Farnoosh Torabi.
2. Build or boost your emergency fund
An emergency fund is an important financial tool that can help you in the event of a job loss, salary decrease or unexpected financial emergency (like a hefty medical bill). Your emergency fund should contain between three to six months' worth of expenses, which is the amount you spend on things like rent, utilities, groceries, gas and other essentials.
Your tax refund can help you get started on building an emergency fund. A high-yield savings account that earns slightly higher interest rates that you can access quickly is a great place to store this money. Many online banks like Capital One, Ally and Marcus offer high-yield savings options.
And, if you have debt you'd like to pay down and no emergency savings to speak of, you might be unsure of how to best put your money to work. "Dedicating time in the beginning to shore up some emergency savings first - even just a few hundred dollars - can be extremely helpful before embarking on your debt payoff strategy. It provides a buffer for unexpected expenses that won't cause you to sink further into debt. Of course, pay the minimums on all your card balances, as you work on building up the savings. But as soon as you have about a month's worth of essential expenses set aside, get more aggressive with your debt payoff plan," says Torabi.
3. Pay your future self
While it may not be the most glamorous way to enjoy your money now, investing in your future is important at any stage of your career. You can use your tax refund to contribute to any retirement plans you have, 401(k)s or IRAs. In 2022, you can contribute up to $20,500 to a 401(k) and $6,000 for traditional and Roth IRAs. (If you're over 50, you can contribute an extra $6,500 to your 401(k) and $1,000 to an IRA.)
"If maxing out your workplace retirement plan isn't feasible, consider investing enough to earn your employer's full match or contributing at least one to two percent more than last year," says Torabi.
And, if you're already on track to meet your retirement goals, you could use your money to begin investing. There's no one way to begin investing; it will look different for everyone. If you'd like to invest with minimal risk, purchasing an ETF (exchange-traded fund) or index fund might make sense. Both options spread out your risk across different stocks and bonds that track a particular index, like the S&P 500. You won't get rich overnight with index funds or ETFs. They're more of a long-term play.
If you want to take a more active role in investing and don't mind taking on higher risk, you could invest directly into the stock market through a brokerage. A few online options for investing in ETFs, index funds and stocks include TD Ameritrade, ETRADE and Fidelity Investments.
For those who don't want to be as active in the investing process, a robo-advisor might make sense. Robo-advisors like Betterment, Wealthfront and Ellevest use AI to create a portfolio based on your financial needs and goals.
4. Add funds to your HSA or FSA
A health savings account is a savings plan specifically designed for health-related costs. HSAs are a type of investment account, even though they're called "savings" plans. If you have a high-deductible health plan, you're eligible to open an HSA. HSAs are triple tax-free: Your contributions, earnings and withdrawals aren't taxed. Your employer may also offer access to an FSA, flexible spending account, which is also a tax-free account designed for qualifying medical expenses.
If you have a health savings account or flexible savings account for medical expenses, you might want to use some of your tax return towards funding this account. The contribution limits for 2022 for an HSA are $3,650 for an individual and $7,300 for family plans. The FSA contributions limit for 2022 is $2,850.
5. Start a college fund
Whether it's for a child or yourself, you can put your refund to work by investing it for future college expenses. You have a different options for storing this money, including a high-yield savings account, an investment account or a 529 plan.
A 529 plan is specifically made for college savings, but it acts more like an investment account. Earnings grow tax-free and as long as you use the funds for education-related costs, you're not on the hook to pay taxes on your withdrawals.
6. Invest in yourself
While college is a great self-investment, there are other ways you can use your tax refund for a good cause. If you've been contemplating a career change, use your money to invest in that switch. If you need capital to start your own business, this could be your chance. Or use your funds to invest in classes, courses or certifications that will help take your skills to the next level.
"Considering that it may take time before your new business starts to generate revenue, having at least one year's worth of financial runway, or personal savings, can be vital to both your financial security and the long-term success of your business," says Torabi.
The stress of the past two years has taken a toll on all of us. While paying down debt, saving and investing your refund are smart ideas, investing in your mental health is just as important.
Consider using your refund to give yourself a much-needed break -- whether that means a no-laptop staycation, a trip to see family and friends or a relaxing vacation away to recharge, reset and refocus. "Mastering your money takes more than just managing your dollars and cents properly. It's a far more holistic endeavor that centers around your mental well-being above all," says Torabi. "Health is wealth."
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February 13, 2022 at 09:00PM
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Getting a tax refund? Here are 6 ways to invest in yourself - CNET
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