If you're expecting a tax return soon -- or if you've already gotten one -- chances are you probably already have plans for your money. Many people use their tax returns to go on vacation, make home repairs, or go on a shopping spree.
But before you start spending, stop and think for a moment if what you're about to purchase is really the best use of your money. A tax return can provide the means to treat yourself to things your regular budget can't afford, but it can also be a great opportunity to get caught up on your bills, pay down debt, or start investing.
The following are three of the smartest things you can do with your tax refund:
According to the Federal Reserve, the average household has approximately $7,117 in credit card debt, and for those carrying student loans, the average student loan debt is $34,703. If you are carrying debt, one of the smartest things you can do with your tax return is start paying it down. This is particularly true for high interest debt, which can end up costing you thousands if you carry a balance.
Paying down your debt is also good for your credit score, too. Your overall debt load makes up nearly a third of your credit score. If your credit cards are maxed out and you have a mortgage, student loans, and other lines of credit, your credit score is probably hurting too.
With an uncertain economy and a historically high unemployment rate, a savings account is an absolute must. Without an emergency fund, a job loss or unexpected expense like car or home repairs can put you in a bad spot financially.
Financial experts recommend you have an emergency fund that covers at least three months' worth of expenses. This is a good goal to work towards, and your tax return is a great way to start it or contribute to it.
It’s best to have an account that is not linked to your checking account. That way, you’re not tempted to draw from it if your checking account balance is low.
Investing your tax return is another smart option. There are a number of different ways you can invest your money, depending on your financial goals and the amount of risk you’re willing to take.
Safe investments include CDs (certificate of deposit), which have higher interest rates than savings accounts but charge you a penalty for early withdrawal. Most CDs are between one and five years. After that period, you can reinvest the money, or you can cash it out.
A Roth IRA is another good option, particularly if you’re young. This is a retirement account that grows in your account tax-free. You can also withdraw money from your Roth IRA without penalty for the purchase of your first home or for higher education expenses.
Combining these options is also a good idea. For example, if you have credit card debt but no savings, you could put half your tax return towards your debt and half towards your savings.
If you are absolutely set on splurging with your tax return, try and compromise by putting at least a portion of it away for savings or debt reduction and using the rest to spend however you want.
Your tax return is a great way to get ahead—or get caught up—financially. Tax returns only come once a year, so make sure you spend your return wisely.