Five Smart Ways to Use Your 2021 Tax Refund

Apr 15, 2022
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If you haven’t completed your 2021 tax return and expect to get a refund this year, you might want to file as soon as possible. Not just because the deadline for most taxpayers is coming up on Monday, April 18, but because you might be entitled to sizeable funds that the government has been holding interest free for the past year. According to April 2022 reports, refunds are averaging $3,226 thus far this tax season – a double-digit percentage increase from 2021. But if you’re someone who tends to burn through a new injection of cash before you have an accurate accounting of where the money goes, you might appreciate some tips on how you can use your refund to boost your financial well-being. For those who want a failsafe plan to ensure your refund is not frittered away, consider one or more of these suggestions before dipping into those hard-earned funds:

Jumpstart your emergency savings account

Most of us are aware that experts advise we keep a financial cushion of three to six months’ worth of living expenses in an account that is accessible, but separate from the one we use every day. These funds can provide peace of mind and security as a resource to tap into in the event of an emergency such as a job loss, a death in the family, or a major illness. An emergency fund might also be used for unexpected expenses like a major car or home repair, dental or medical bills, important travel (e.g., visiting an ill family member), etc. Building a sufficient cash buffer like this can go a long way toward helping you to avoid racking up debt if your finances hit a snag.

But according to the financial regulatory authority FINRA, most people are substantially behind in building their emergency savings accounts, and roughly 54 percent of us don’t have any emergency savings at all. So, if you haven’t created an emergency account, you’re far from alone, but a tax refund is a great way to get one started. For most people, fully funding an emergency account can be helpfully thought of as a major savings goal for improved financial health. If you’re looking for a safe place to grow these funds, one great option is a money market account. Not only is it a liquid asset that provides instant access to your cash, but it generally offers a higher rate of return than a basic savings account.

Eliminate or reduce any high-interest debt

If you’ve already established an adequate supply of cash resources but carry a balance on your credit cards or have other interest-bearing debt, one of the smartest moves you can make with your tax refund is to pay this down. When you consider the impact of compound interest (interest on interest) and the fact that credit card interest rates on accounts with balances average more than 16.00%, it’s easy to understand how this form of debt has become a major hindrance to financial security for so many Americans.

Taking steps to whittle away high-interest debt can potentially save you hundreds, or even thousands of dollars over the long haul. Depending on your individual credit history, paying down your revolving debt may also significantly improve your credit score, because doing so can effectively lower your credit utilization ratio. Simply put, credit utilization is the percentage of credit you’re using as compared to your credit limits. You’ll ideally want to get this ratio as low as possible, since your level of debt/credit utilization is the second biggest factor affecting your credit score.

For the most cost-effective way to knock out credit card debt, pay down your card with the highest interest rate first, while making sure to make the minimum payments on your other cards. Once this account is paid in full, move on to the card with the second-highest interest rate, and continue this process until you’ve paid all balances in full.


Fund a retirement account

If you’re behind on retirement plan contributions, keep in mind that the IRS allows you to have your tax refund deposited directly to an IRA, ROTH IRA or a SEP IRA. Especially if you don’t have an employer-sponsored plan like a 401 (k), this is an option you might want to consider. And if you’ve yet to start saving for your retirement, your refund is an easy way to start building your nest egg. Consider that the earlier you invest, the more time your money has to compound and grow to increase your wealth, and protect your spending power from inflation. Just keep in mind that there are limits to how much you can contribute to a tax-advantaged retirement fund each year. Find “2021-2022 Retirement Contribution Limits” at SmartAsset.

Do some basic upkeep on your home

While landscape enhancements and a bathroom remodel can provide a high return on your investment, it’s important not to overlook the importance of keeping your home structurally sound, well-maintained and functional when considering your home improvement budget. Putting your tax return to use on something like basic home maintenance will not only enhance your quality of life, but it can improve your home’s value and prevent you from incurring the high cost of repairs due to deterioration.

If you’ve noticed problems with systems like plumbing, air conditioning or faulty electrical wiring, make it a priority to address these issues so you’re not faced with unmanageable expenses down the road. Also take care to repair structural issues like cracks in your walls and a leaking roof before they result in water damage, mold, mildew, etc. Simple upgrades like new siding and window replacements also tend to be good investments when it comes to resale value. For an overview of home upgrades that rate among the highest in a cost versus value analysis, check out “Which Home Improvements Pay Off” from HGTV.

Start funding a longer-term goal

If you’re set on a future goal like buying a home or getting an advanced degree, your tax return is an excellent way to start saving for it. However, you’ll want to keep this money separate from both your checking account and the savings account that you use to build your emergency fund. For credit union members, a good place to consider parking these funds might be a Certificate. An alternative to a basic savings account, a Certificate provides a higher rate of return, usually at a guaranteed fixed-interest rate. When you deposit money into a Certificate account, you’re required to leave it there for a specified period of time, such as 3-18 months. If you withdraw money early, you’ll have to pay a penalty. Because there are more restrictions with regard to access to funds, a Certificate is well suited to those who are saving for a medium or long-range goal, and want to avoid the temptation to tap into this money too easily.

Ultimately, the best use of your tax refund depends on your own unique needs, as well as your personal interests, aspirations and overall financial situation. For some, meeting a new financial goal may be less critical at the moment than making a purchase that will contribute substantially to their overall happiness and well-being. While a day at a luxury spa or exorbitantly priced season tickets may not be the most responsible way to spend this cash, using your refund toward laser eye surgery or to attend a close friend’s wedding in a distant state may well be a meaningful investment. As long as spending your refund doesn’t induce feelings of guilt, you’re probably making the right choice for you.

 

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