Tax season is upon us, leaving millions of Americans waiting for that fat check from Uncle Sam.
It sounds like a great time to put a nice down payment on a new car or book a beachfront condo in Florida.
With the average tax refund being over $2800, it’s no wonder people get excited to ball out! That’s a lot of money to get all at once.
But what if instead of throwing your money away on something you don’t really care about, you ~gasp~ spent it on furthering your financial future?
Your tax refund is money that you should have recieved throughout the year, anyway. It’s not “free money” from the government like some people think it is!
I know a trip to Vegas is more fun right now than investing for your future or paying off the credit card debt that you accrued during the holidays, but you won’t regret doing something smart with your money.
And it doesn’t have to be so black and white. You can be financially wise with the majority of your refund, and spend the rest on whatever you want!
It’s all about balance.
But maybe you’re not quite sure what a “financially wise” decision would be.
If you’re wondering what to do with your tax refund this year, here are 5 smart things to consider.
How Tax Refunds Work
Taxes are way more complicated than they should be in this country.
I get it, we all have pay our “fair share,” but know one knows exactly what that “fair share” is until you tell some fancy tax software (or your CPA) a bunch of random numbers to spit out your federal tax liability.
In a nutshell, it works like this: your employer withholds money from each paycheck and sends it to the IRS.
At the beginning of the next year, your employer sends you a W-2 to tell you how much gross income you earned along with any pre-tax deductions that came out of your paycheck.
From that information, the IRS can calculate your federal tax liability, aka, your “fair share” in taxes that you owe Uncle Sam.
Your tax software then compares how much your employer already paid to the IRS on your behalf, and compares it to your federal tax liability.
- If you get a tax refund, that means you overpaid your taxes throughout the year.
- If you end up owing money, that means you underpaid your taxes throughout the year.
- If you’re like Goldilocks, and don’t get a large refund or don’t owe much, you paid just the right amount of taxes throughout the year.
If you’ve never looked at how much gets withheld from your paycheck, I’d encourage you to do so! You’ll likely be astounded at how much it is.
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What to Do With Your Tax Refund in 2023
If you’re planning on a large tax refund this year, here are 6 smart ways to use it! You’ll thank yourslef for spending your tax refund wisely.
#1 – Build Your Emergency Fund
If you don’t have an emergecy fund yet, I highly highly recommend using your entire tax refund to get that started ASAP.
You never know what life is going to throw at you. Having no money in savings is a dangerous place to be.
Not only are you asking to go into credit card debt anytime something unexpected happens, but having no money in savings is likely taking a toll on your mental health as well.
Don’t do anything else with your money until you have at least 1 months’ worth of expenses in a savings account.
Your “fully funded” emergency fund should ideally be between 3 and 6 months of expenses.
Do yourself a favor and use your tax refund to start building that solid financial foundation. An emergency fund is the first step to being financially secure, always.
Or maybe you recently needed to use your emergency fund, and it needs beefed up a bit. Both are great reasons to put your tax refund in savings!
Related: How Big Should Your Emergency Fund Be?
#2 – Save for a Large Purchase
Do you have any large purchases or events coming up soon? It might be a good idea to get a head start on saving for those now!
If you’re planning a wedding, vehicle purchase, or are moving soon, you could allocate your tax refund toward saving for one or more of those items.
Saving for a large purchase should be kept separate from your emergency fund. A new couch is NOT an emergency, ya’ll.
Take some of the financial stress of large purchases away by saving for them ahead of time.
How awesome would it feel to have all the money you need for your next vacation sitting in savings ready to be spent guilt-free?
#3 – Open and Fund a Roth IRA
Another great option if you’re wondering what to do with your tax refund is to open a Roth IRA and put it toward retirement!
A Roth IRA is a tax-advantaged retirement account that grows tax-free. So it’s it’s kind of fun to take your tax refund and invest it in a way so that you never have to pax taxes on that money again!
A Roth IRA is an amazing way to save for retirement, especially if you don’t have a 401k through work (although I still contribute to both my 401k and my Roth IRA each month).
The annual contribution limit is $6500 (for 2023) and it is completely separate from your employer.
You can open one in a few minutes with any broker! I personally use TD Ameritrade, but Vanguard, Fidelity, or Schwab are great options too.
Your tax refund will give you a great head-start on maxing out the account for the year!
Plus, the average tax refund of $2827 will grow to over $28,000 in 30 years! And it’s all tax-free money!
If you want to learn more about Roth IRA’s, I highly recommend taking this investing course.
It will teach you everything you need to know about retirement accounts, index funds, and how to get started building wealth for financial freedom in 6 easy to understand lessons!
It’s the only course I recommend on this topic because it’s affordable and the creator practices what he preaches (and has a net worth of over $4 million at age 36).
I follow the strategies taught in this course and have built a retirement nest egg of over $100,000 by age 26.
This isn’t a get-rich-quick scheme, but it works.
#4 – Pay Down High Interest Debt
Have some leftover credit card debt from the holidays? Use your tax refund to clean that up! (And then start saving your Christmas fund now, so you don’t go into debt again next year).
A smart thing to do with your tax refund is to make a lump-sum payment to your highest-interest debt. Maybe you have a student loan or car loan you’re working on getting rid of.
Think of paying off debt as buying your freedom back. Every dollar sent to the bank as a debt payment is a dollar that you don’t have control over.
Once you pay it off, you won’t have to make those payments anymore!
Trust me, I know how it feels! I graduated with $56,000 in student loan debt and was able to pay it off in 2.5 years because I made so many extra payments (including throwing any windfalls, like a tax refund, toward my debt).
Your tax refund can be a great opportunity to start (or continue) your debt free journey and save money on interest as well!
I recommend paying off the highest interest rate debt first, but if you’re interested in learning more about debt payoff strategies, check out this post: Debt Snowball vs. Avalanche Method: Which Debt Payoff Plan is Best for You?.
#5 – Take Care of Home or Car Maintenance
Another smart thing to do with your tax refund this year is to finally do that home repair or car maintenance item that you’ve been putting off.
If your car needs new tires or brakes, now is a great time to get that taken care of. Taking care of your current car will ensure that it lasts as long as possible, saving you money!
Same thing goes for your home. Small repairs now can turn into large, expensive ones if not repaired in a timely fashion.
Plus, some of these maintenance items can be expensive, so go ahead and take care of them with your tax refund so your regular monthly budget isn’t affected.
Related: 8 Important Things to Do After Buying a Used Car to Save Money
#6 – Make an Extra Mortgage Payment
Maybe you’re in a super-stable financial situation- you don’t have consumer debt, you have a solid emergency fund, and you have your retirement savings going.
You might be thinking, “what’s next?”
Making an extra mortgage payment with your tax refund might be a smart move!
I know that some people are against paying down “good debt,” such as a mortgage, but eliminating your largest monthly expense can be so freeing.
Making one lump-sum extra payment of $2827 will save you 7 months of mortgage payments! (Assuming a $250,000 loan at 3.5% interest).
Plus, you’ll be building equity in your home and will get that money back when you go to sell.
Paying extra on the mortgage might not be for everyone, but it’s definitely NOT a stupid idea.
That being said, I would not use my tax refund toward the mortgage until I had no other debt, a fully-funded emergency fund, and was on track with my retirement savings goals.
How a Lower Tax Refund Can Be a Good Thing
Psychologically, it feels really good to get an extra $2000 – $3000 hitting your bank account all at once. But getting a large tax refund every year might not be a good thing.
Getting a huge refund means that you overpaid your taxes throughout the year, and the government is giving your money back in the form of a refund.
Your tax refund money is money that you should have recieved in your paycheck throughout the year.
Oh, they also don’t pay you any interest for holding onto your money for a year, either.
And with inflation hitting an all-time high of 7% since 1982, you lost 7% of the purchasing power of your tax refund by waiting to get it in a lump sum at tax time.
Ideally, your tax withholdings should be as close to ~just right~ as possible. This ensures that your take-home pay is actually correct (higher tax withholdings mean less money in your paychecks).
You can adjust your tax withholdings on the form W-4 with your employer.
If you way overpaid your taxes this year, it might be a good idea to make some changes. The IRS updated this form in 2020, so it should be a bit more straightforward to fill out.
So if you’re always wondering what to do with your tax refund, ask yourself what you would have done with an extra $200 or so each month (and think about the ideas presented in this post!).
Hopefully you’re not asking this question again next year because your refund will be so small!
Did you get a big tax refund this year? Did this post change your mind at all? Let me know in the comments below!
-Megan
Read next: Big Tax Refund? Here’s Why You Shouldn’t Celebrate It
Megan is an automotive engineer, newlywed, and personal finance blogger from the midwest. She found her passion for personal finance after starting her first “real job” after graduating college. Now, she helps other young professionals become more intentional with their money in order to build wealth for financial freedom. In her free time, she loves to travel, hike, and play euchre with her family. Read more about her story here.