Most taxpayers have received an average tax refund of $3,000 for the past two tax filing seasons according to the IRS. That is a nice amount of money of which one could use in many positive ways to help them start establishing a positive change in their net worth. Following are eight smart uses for your tax refund:
1. Start or increase your emergency fund for those unexpected events that could occur at anytime. Having such a fund can help you avoid landing in credit-card debt. In your emergency fund you should always have three to six months of funds available for unexpected surprises. Keep the money easily accessible in a money-market account or savings account that earns interest
2. Pay down high interest debt. Use your refund to pay off a balance with a high interest rate. And if you pay off your balances, you can afford to close some cards that are now charging high fees.
3. Boost your Retirement Savings. You can contribute up to $5,500 to an IRA for 2014 (or $6,500 if 50 or older) — and withdraw the money tax-free in retirement. You can contribute the full $5,500 as long as your income falls below $114,000 if you’re single, and $181,000 if you’re married filing a joint tax return. The contribution limit is then phased out incrementally if you make between $114,000 and $129,000 (single) or $181,000 and $191,000 (married-joint). If you work and your spouse does not, you can also contribute to a Roth IRA in his or her name if your joint income is within those limits. If you earn too much for a Roth, you can contribute to a nondeductible traditional IRA, then convert it to a Roth.
4. Invest in a mutual fund. Use the extra cash to buy shares in a mutual fund or stock you’ve been considering — but may feel is too risky for your IRA or not available in your 401(k) plan.
5. Get caught up on old bills. For many people a tax refund can be a lifeline in getting caught up with overdue mortgage payments and other bills. This can prevent you from losing your home or car, save you money in interest and penalties, and stop future damage to your credit report. However, you may want to think twice about paying that debt if you’re planning to file for bankruptcy or the debt is old enough to be off your credit report and past your state’s statute of limitations.
6. Contribute to an education savings account. After your retirement plan is on track, you can save for your children’s education in a 529 or Coverdell education savings account and have the money grow tax free for education expenses. If you invest in your own state’s 529 plan, you may be eligible for a state income tax deduction. Contributions made by April 15th may be eligible for a deduction on your 2012 state tax return. Just be aware that the earnings may be subject to taxes and a 10% penalty if used for non-qualified expenses.
7. Purchase U.S. Savings Bonds. If you’ve maxed out your retirement accounts, U.S. Savings Bonds offer you another vehicle for tax-deferred growth (plus, they are tax free at the state and local level). Series I Savings Bonds are currently yielding 1.76% and the interest rate is adjusted every six months for inflation. Series EE Savings Bonds are currently yielding only 0.2%, but because they double in value after 20 years, you’ll earn about 3.5% if you hold them that long. Those rates may not sound too exciting until you compare them to 5-year CDs, which are averaging less than 1%, or 20-year Treasury bonds that are yielding about 2.8%. Unlike 20-year Treasury bonds, you don’t have to worry about savings bonds losing value if interest rates go up, and they may be tax free if used for education expenses. On the other hand, you can’t cash them in for the first 12 months, so they’re not suitable for emergency savings (at least for the first year). You also lose the last 3 months of interest if you redeem them within the first 5 years of issue, but the series I savings bond would still be ahead of the average 5-year CD after just 12 months even with the penalty. You’re normally limited to purchasing $10k per year on treasurydirect.gov, but you can purchase an additional $5k in paper I bonds each year with IRS refunds using IRS Form 8888.
8. Invest in your home. Your refund won’t be enough to redo your kitchen or bathroom, but it can pay for some smaller home improvements. Use the extra cash to add a backsplash, paint a room or cabinets, replace your bathroom sink, swap out your faucets, organize a closet, install a programmable thermostat or spruce up your yard. All of these improvements may add value to your home.