7 Money-Smart Ways to Spend Your Tax Refund
Since this year's tax deadline was pushed back to May 17, many people are just now filing their tax return. That means there are a lot of tax refunds yet to be cashed and spent.
The average federal tax refund so far this year is $2,865 – up from the average for 2020. But instead of using the money for a summer vacation, many people who have lost their jobs because of the coronavirus pandemic will need to use their refunds to pay the mortgage or buy groceries.
If you're fortunate enough to have the essentials covered, you may be tempted to treat yourself to takeout from your favorite restaurant or a nice bottle of wine. Fine. But once you've scratched that itch, consider these ways to put the rest of your tax refund to work for you.
Shore Up (or Start) Your Emergency Fund
Even if you're working now, there's no guarantee that your hours won't be cut, your salary reduced, or your job eliminated. That means it's more important than ever to have money set aside for emergencies. That way, you won't have to run up credit card debts or raid your retirement savings to pay the bills until you get back on your feet.
Aim for six months of living expenses — more if you're the sole provider for your family. Interest rates are abysmally low right now, but you can eke out higher rates by putting your savings in an online bank account. Look for one with no minimum balance requirement or monthly fees.
Pay Off High-Interest Debt
While interest rates have been falling, most credit cards still charge upwards of 15%. Pay off those unpaid balances and you'll get a return on your investment a successful hedge fund manager would envy. If you're able to pay off the entire balance, you'll also eliminate a monthly expense, which will give you some breathing room if you lose your job.
Save for Retirement
If you have a Roth or traditional IRA, consider putting some of your refund money in the account now so you'll have more money when you retire. If you don't already have an IRA, think about getting one. The maximum amount you can contribute to your IRAs in 2021 is $6,000 — $7,000 if you're 50 or older — so you can stash your entire refund there if you don't need it for anything else.
If you're not inclined to build your own portfolio, consider investing in a target-date fund, which will invest in a mix of stocks and bonds, based on how many years you're away from retirement.
Support a Worthy Cause
Food banks have been overwhelmed in recent months, and other non-profits that provide social services to people in economic distress are also stretched to the limit. Donating some of your tax refund will help them fulfill their mission, and you'll get a modest tax break, too. In 2021, taxpayers who claim the standard deduction can deduct up to $300 in cash contributions to charity. The deduction is per person, so a married couple who claims the standard deduction can deduct up to $600 in cash contributions (in 2020, the deduction was limited to $300 for married couples).
If you itemize, the amount you can deduct for cash contributions is usually capped at 60% of your adjusted gross income (any cash donations over that amount can be carried over for up to five years and deducted later). However, the limit was removed for the 2020 and 2021 tax years (although there's still a 100%-of-AGI limit on all charitable contributions). As with the $300 deduction for non-itemizers, this tax relief measure doesn't apply to donations to donor advised funds and supporting organizations, or to most cash contributions to charitable remainder trusts.
Invest in a 529 College Savings Plan
Contributions to a 529 college savings plan grow tax-free, and withdrawals aren't taxed if you use them for qualified expenses, such as college tuition and room and board. You can invest all or a portion of your tax refund — 529 plans typically have very low minimums. Plus, your state may give you a tax deduction or credit if you invest in your own state's plan. If your children are young, you have many years for investments in the plan to compound and grow. To research plans, go to savingforcollege.com.
Protect Yourself from Unexpected Health Care Costs
If you have a high-deductible health insurance plan (a deductible of at least $1,400 for single coverage or $2,800 for family coverage), you can contribute to a health savings account. An HSA gives you a triple tax break — your contributions are tax-deductible (or pre-tax if through your employer), the money grows tax-deferred, and you can use it tax-free to pay out-of-pocket medical expenses in any year (there's no use-it-or-lose-it rule).
The CARES Act increased the types of expenses that are eligible for tax-free withdrawals from your HSA. In addition to health insurance deductibles, co-payments, prescription drugs and medical expenses that aren't covered by your insurance, you can use tax-free withdrawals to pay for most over-the-counter medications and feminine-hygiene products. Although health-insurance premiums are typically not considered qualified medical expenses, there's an exception if you use withdrawals to pay COBRA premiums or for other health-insurance premiums if you're collecting unemployment benefits.
Protect Yourself from Natural Disasters
Hurricane season is almost here, so if you live in a vulnerable area, consider using your refund money to protect your home. A home generator will keep the lights on and the food cold during a power outage. A 6.5 kw portable home generator costs about $800 to $1,000. You also can use the money to pay someone to trim your trees, which will help protect your home from some of the most common types of storm damage.
