Hear that? It’s the sound of *Future You* asking for a high five.
We don’t mean to be the fun police but a tax refund is not free money…it’s YOUR hard-earned money coming back to you! So, if Uncle Sam hands you some cash back, what’s the best thing to do with it? Which choice do you think Future You will thank you for?
Many of us are getting our tax refunds right now, so let's take a look at some of the best ways to spend it.
1. Pay Off That High Interest Debt
First thing you want to do is examine your financial situation, and determine whether you have any debts to pay off. Do you have any high-interest credit card debts or personal loans that would benefit from you putting a large chunk of money toward that? If you have credit card debt, we recommend paying it off first, because high-interest credit card payments are likely to eat into any investment gains, (or cancel them out altogether). With any financial move, you want to make progress rather than merely tread water. So, if you've set aside an emergency fund, apply those extra tax funds toward paying down your credit card debt.
Paying off debt can also help you improve your credit score and your debt-to-income ratio, or DTI, which is a percentage that gauges how much of your monthly gross income is impacted by your obligations and is used by most mortgage lenders to determine whether or not you qualify for a loan. If you're looking for a home, this could be really beneficial. You'll mostly hear about two debt-paying methods: snowball and avalanche, so pick one and get started!
The snowball method involves paying down your debts in order of lowest to highest balance. This provides you with some momentum and encourages you to continue paying down your debt.
The avalanche method, on the other hand, is paying off your debt with the highest interest rate first in order to avoid paying far more in interest than necessary.
2. Fund Your Retirement Accounts
If you've opened a Roth IRA, you've already laid the foundation for one of life's most important aspects: saving for your post-working (golden) years. Well done.
While it may not be the most exciting way to enjoy your money at the moment, investing in your future is important at any stage of your career. You can put a chunk of your tax refund toward any retirement accounts you have, such as 401(k)s or IRAs.
You can contribute up to $20,500 in a 401(k) and $6,000 in traditional and Roth IRAs in 2022. (If you're over 50, you can increase your 401(k) contribution to $6,500 and your IRA contribution to $1,000.)
3. Put Those Tax Dollars to Work
According to the IRS, the average tax refund in 2021 was $2,827. If you invest that money now and achieve a 10% average yearly return, it will grow to roughly $50,000 in 30 years.
Keep in mind that these calculations assume you're not making any additional contributions. If you were to continue investing even a little each month, you could earn significantly more.
Assume that in addition to your current investment of $2,827, you also contribute $100 every month. If all other circumstances remained constant, you'd end up with about $247,000 after 30 years. In the same time frame, if you invested $200 per month, you would have $444,000 in your account.
Investing in the stock market is a fantastic way to build wealth, and you don't need a lot of money to get started. By investing as much as you can afford and then giving your investments time to grow, you can earn more than you might think.
4. Build That Emergency Fund
We can all agree that the coronavirus pandemic showed us how awful it can be to suddenly lose income and not have savings. So, what better way to kick-start your emergency fund by using your tax refund?
A good rule of thumb would be to set aside enough money to cover three to six months' worth of expenses. Don’t feel overwhelmed by this amount. Even if your emergency savings are close to zero currently, any amount you start with will help.
In addition, your tax refund may cover a week — or even a month — of expenses. That's a great foundation to start on. You'll be more prepared if something unexpected occurs.
“An investment in self-development pays the highest dividends.” ― Debasish Mridha
If you want to make 2022 the year you use your tax refund wisely, follow these steps: Examine your financial situation, make a plan, and celebrate the steps you make today!
If you are unsure of what to do or require any financial guidance, click here to get connected with a #VincereWealth advisor. We will use this time to get to know one another and answer any burning questions you might have.