3 Smart Things to Do with Your Tax Refund to Make It Grow
If you’re one of nearly 126 million people expecting to receive an income tax refund next year (and that’s almost 75% of Americans), that’s probably the largest windfall you’ll receive all year. What will you do with that money? In 2020, the average refund was almost $3,000. More than 65% of refund recipients
said they planned to use their refund money paying down debt or spending it on everyday expenses; 15% planned to spend it on a major purchase, like a vacation or big-screen TV.
Only 7% of refund recipients planned to invest their state and/or federal tax return — possibly because they don’t know how to invest it. If you’re among the 7% who plan to invest your income tax return, good for you! You’re planning for tomorrow instead of spending for today. And though a big-screen TV or exotic vacation sounds like fun, consider this:
Over the past 10 years, the stock market’s average rate of return has been about 9.2%, according to Goldman Sachs data. If you invest your $3,000 in the stock market, and add nothing more to that sum
, in just 10 years your $3,000 investment
will be worth about $7,000.00.
An investment in the stock market might sound too risky for you right now. Or you may have other savings goals you want to reach. So let’s look at some of the best ways to invest your income tax return before you get your refund check in the mail.
3 best ways to invest a tax return
1. Pay off your debt.
We all know there are different kinds of debt. If you own a house, you probably owe on your mortgage. Or perhaps you have student loans. It’s debt, but it can benefit your livelihood
Other debt, such as auto loans or credit cards have the added cost of interest that typically offsets the value of your purchases. Use your income tax return to pay down or pay off the bad debt you owe. A smart rule of thumb is to pay off the debt with the highest interest rate, which is typically credit card debt. Then once the high-interest debts are paid off, pay off the next debt that has your next-highest interest rate.
Another effective strategy is to pay off your smallest debt first, then move on to your second-smallest, and so on. This is called the snowball method, and it works because you simply pay what you were paying on your smallest debt toward your second-smallest debt, adding the extra amount you now owe. (If your smallest debt is $100 and your second-smallest debt is $150, you pay off the $100, then continue paying $100 and add $50 to pay off your second-smallest debt, and so on.) Using the snowball method, you essentially increase the payment incrementally with each debt until all your debts are paid off.
2. Create an emergency fund.
More than half of Americans have less than three months’ worth of their living expenses covered in an emergency fund. And of those Americans, 25% of them say they have no emergency fund at all. Which means if they have an unexpected expense like a car repair — or if they lose their job — 25% of Americans don’t know how they’d cover costs like housing, food, gasoline and utilities.
Use your income tax return refund to start or build up your personal emergency fund. Everyone’s emergency fund amount will be different, based on your lifestyle, monthly costs, income, and whether it’s just you or your spouse and children. A good guide is to save at least three to six months worth of expenses.
You don’t need to save it all at once; build it up over time. Put it into an interest-earning savings account or in a money market account — somewhere you can quickly and easily access the money without a penalty (which means, don’t put it into your 401(k) or a Certificate of Deposit).
If you must withdraw the money for a genuine emergency, prioritize paying yourself back as soon as you can. You never know when the next emergency may arise, but you’ll always be prepared for it.
3. Contribute to a retirement account.
You can invest your tax return refund in an IRA or other type of retirement account. To know which type is right for you, talk with a financial advisor.
If you’re working, use your tax refund for everyday expenses and increase the amount you’re contributing to your 401(k) retirement plan. For example, if your employer offers a contributing match of 6%, and you’re only putting in 3%, meet or exceed that match. If you’re over 50, put more of your paycheck into your 401(k); people 50 and older are eligible for a catch-up contribution of an extra $6,500, for a total of $27,000.
Talk with the experts at First National Bank and Trust.
You work hard all year long for your money. And you’ve got many financial goals for today and tomorrow. We can help you achieve both your short- and long-term goals with a smart mix of investment options that are right for you.
You don’t need to wait until you receive your income tax refund to talk with us — simply visit us at one of our 16 full-service locations throughout southern Wisconsin and northern Illinois, or contact us to learn about our investment services.