11 Smart Things to Do With a Tax Refund
One of the best investments is paying down high-interest debt. For example, the average annual percentage rate for credit card interest is nearly 16 percent, so paying down credit card debt is essentially like getting a risk-free 16 percent return on an investment.
Some companies match a portion of a worker's contribution to an employer-sponsored retirement plan such as a 401(k). Employees who do not already contribute enough to get the maximum employer portion could consider contributing more. The rules do not allow lump-sum investments into a 401(k) -- the contribution must be deducted from a paycheck -- so use the tax refund money to make up the difference in take-home pay after increasing the amount withheld from a paycheck.
People without high-interest debt who already get the maximum allowed match from employer-sponsored retirement plans could use tax refund money to establish or contribute to an Individual Retirement Arrangement. An IRA offers tax advantages and greater flexibility with investment options than a 401(k) plan. A traditional IRA lets account holders defer paying taxes on the money they contribute (in practice, that means taking a tax deduction equal to the amount put in the account) until money is withdrawn. With a Roth IRA, income taxes are paid on the contributions, but the principal and earnings can be withdrawn later tax-free.
Debt is not inherently bad, and in some cases it may make more sense to invest than to pay off debts early. For instance, if an investment offers an expected return of 5 percent and the interest on a loan is 3 percent, investing represents a net gain. But there is more risk involved, and some people may feel more secure without any debt than they would with the potential for a small return on their money.
Unlike an emergency fund, an opportunity fund allows for timely purchases without worry -- such as buying a TV or computer when it goes on sale for a short time. This could also mean having the "opportunity" to donate when a friend or family member needs financial help.
Saving is not always fun, but it can buy something fun. If the practical things such as debts, emergency fund, big short-term goals, and retirement accounts are covered, designate the windfall for something more exciting, such as a big vacation.