Every year, the IRS sets aside a large budget for tax refunds. And this means that everyone who qualifies for a tax refund looks forward to some extra cash for vacationing and shopping. While it feels like you’ve earned that money or that the government owes you, it’s worth mentioning that you could use that money differently. No, we aren’t telling you how to use your money, all we want you to know is that your tax refund could be put to better use as you’ll see.
Even though you’ve dreamt of that summer vacation for way too long, here are some of the strategies you could use to make the most out of your tax refunds.
Set up an emergency fund
What is your savings balance? Is the number one that makes you proud or is your account the last thing you could turn to if things went sideways? Your situation notwithstanding, why not convert the free money from the IRS into money that will save you on a rainy day? So, if you don’t mind making one smart move this year, use your tax refund as seed money for your emergency fund. You could also put that money in the money market or a short-term CD to help you cater for any future emergencies.
The best part is that your bank could give you a great promotional deal with a bonus package that depends on the money you save up.
Increase the amount of money you put to your retirement contribution
Any tax professional, including a Toronto tax evasion lawyer and financial planners, will encourage you to reduce the value of your refund if you can and also to grow the money instead of loaning it. Since your tax refund means that you loaned your government interest-free money, you should adjust all your withholdings instead and then use the extra money to increase your 401k contributions.
Clear your debts
The hard truth is that your wants and the feeling of entitlement can drive you deep into debt. The free money from the government may feel like just another solution to your wants but, don’t you think you’ll have a sound mind if you were to use the tax refund to pay off the high-interest credit cards, student loans or you may want to save that money?
Paying off credit will improve your credit score and even increase your chances of getting a good line of credit when you really need it.
On the other hand, if you’ve paid off all your debt, you should consider putting that money into a dividend reinvestment plan. This is a simple investment strategy that will eventually earn you good and steady income. The best part is that the tax deductibles from the dividend reinvestment plans are low.
I know what you’re thinking: how can I make an investment when the tax refund isn’t as much? Well, you have to start somewhere and to earn more, you have to grow your portfolio. Note that the investment plans leverage the power of compounding effects. So, look at what you’ll have in investment income 5 years from now.
It’s never too late to start, and the best thing is that you can start your Roth IRA at any time. So, instead of using that money to buy a new gadget, make it seed money for your retirement even if you have a workplace retirement account.
Note that you can maximize what your employer contributes towards your retirement using the tax refund used to match the contribution. As a young employer, you could opt for Roth IRA on top of what your employer offers because it’s a lot more flexible than other workplace retirement accounts because Roth IRA accounts let you invest in anything you want: be it real estate, bonds, mutual funds or stocks. The other reason why is that the earnings from these investments will grow tax-free as long as you don’t get your money out before you are 59.5 years.
Need more motivation? Roth IRA has exceptions, and you can avoid penalties for withdrawals made early. They are also easy to understand.
Invest the tax refund in Index funds
Think of the tax refund as an accidental tool for savings and use the money save up to build your portfolio with index funds. This works best if you’re unable to put aside money to help you meet your long-term goals. To make the most out of this investment, put in money every year and ensure that you have a high-performing mutual fund that uses the dollar-cost averaging strategy. This strategy involves risk reduction thanks to the fact that you’re investing in regular intervals. So, start thinking about your tax refund as your investment capital.
Save money CDS
A certificate of deposits provides you an opportunity to earn interest on the deposits you make in a financial institution. Why is this better than putting money in a savings account? The CDs force you to lock in your deposits in the account for a given amount of time. And, you’re penalized if you withdraw the money before the end of the certificate’s term.
Are these all the possibilities for your tax refund? No. you could also use the money to go back to school, start a business, launch a website for your business or you could use the money to set up a 529 plan for your kid’s college fees. Your insurance could also be paid in full.