With another year behind us, we find ourselves in tax return season once again. While 2021 did bring back some semblances of stability and normalcy, the idea of using your tax return in a responsible way may still come with mixed emotions.
This year, 77% of Americans are expected to receive a tax refund. While the average 2021 tax refund is expected to decrease from 2020’s average $2800 tax return, there are still plenty of reasons to use your tax refund to boost your financial and emotional wellbeing.
Unless you need to use your tax return for immediate expenses like rent or bills, consider a plan to spend your tax refund wisely to help you solve challenges and meet goals. Below, Prosper outlines eight of the best options to use your tax refund this year.
1. Pay off or pay down debt.
Living with debt is stressful, whether you have high-interest credit cards, student loans, car loans, buy-now-pay-later services, or unpaid medical bills. While your tax refund may not get these balances to zero (or close to it), paying down debt is a wise way to use your tax return.
Prosper recommends using your tax refund to first pay down your debt with the highest interest rate – often known as “the avalanche method.” This approach saves you money on interest charges down the road. With the Federal Reserve raising interest rates to combat inflation, you can expect already high interest rates to get even higher.
Or, if you have multiple credit cards with similar interest rates, you can use your tax refund to pay down your smallest balances first – called the “snowball method.” Then,with fewer card balances to pay, you can leverage your tax refund and potentially raise your credit score[1] .
By spending your tax refund to pay down or pay off your debt, you can save money immediately and month-over-month, raise your credit score, and reduce your financial stress.
2. Build or boost your emergency fund.
Another great way to use your tax refund is to start, or build, an emergency fund. The importance of an emergency fund became even clearer through the COVID-19 pandemic. An emergency fund is an essential financial resource meant to help you and your family in events like job loss, salary change, or unexpected expenses like emergency medical bills or natural disasters. Ideally, an emergency should be able to meet between 3-6 months’ worth of expenses. This includes your rent or mortgage, utilities, groceries, transportation, and other essentials.
Your tax refund can help you start, or grow, your emergency fund. If you recently started saving, look for a high-yield savings account – preferably one that accrues interest at a higher rate and that you can access quickly. These are available at several online banks.
As a bonus, putting your tax refund into an emergency savings account keeps it out of your checking account – and away from any spontaneous spending sprees (no judgment!).
3. Invest in Yourself
While investing in yourself – aka putting money aside – isn’t always easy, it can certainly result in direct personal gain. You can use your tax refund to invest in yourself by:
- Professional Development: One of the best ways to spend your tax return is to invest in your professional development. Enroll in a certification course or technical training. If you’ve been thinking about a career change, use your tax refund to facilitate a switch. Or go big, and start a college fund for yourself, or apply for graduate school. Whichever you choose, there may even be future tax benefits available through the Lifetime Learning Credit. According to the IRS, “this credit can help pay for the undergraduate and professional degree course, gaining new technical skills or even enrolling in graduate and professional degree courses – including courses to acquire or improve job skills.” This credit is worth up to $2,000 per tax return. There is not a time limit on when you can claim it.
- Start Your Side Hustle: Use this year’s tax refund to make your dreams a reality. Get your Etsy up and running or turn your tax return into the capital you need to get your small business off the ground.
4. Build Your Retirement Account
No matter the stage in your career, keeping your retirement in focus is important. Your tax refund can go a long way toward that goal. There are a few simple ways to use your tax return to save for retirement and even save you money in the future. You can use your tax refund for any retirement plans you have, whether 401(k)s or IRAs. If you don’t already have a retirement plan, use your tax refund to invest in a traditional or Roth IRA through a trusted financial advisor.
5. Invest in Your Children
The cost of college and secondary education continues to rise and shows no signs of slowing. Using part of all of this year’s tax refund to start a 529 College Savings Plan for your children (if you have them, of course!) Like retirement plans, savings in a 529 plan grow tax deferred. While you can’t deduct your contributions from your federal taxes, you don’t have to pay taxes on the withdrawal you make for future tuition payments.
6. Buy a Life Insurance Plan
Anyone who has shopped for life insurance can attest to the high price tag. If buying a life insurance policy has been cost prohibitive in the past, spending your tax refund on life insurance can help to secure your family’s future.
7. Donate Your Refund To Charity
If you want to up your charitable giving this year, consider putting some of your tax refund aside to support a charity or charities of your choice. Not only will donating your tax return help your community and make you feel good, most charitable donations are tax deductible (for next year’s tax season.)
8. Treat Yourself!
While Prosper does, of course, encourage practical financial planning, we believe that life is about balance. After all, the stress of the last two years has taken its toll on everyone. For some, treating yourself with your tax return may be just as important as using it wisely.
Consider using your tax refund to give yourself a break. Take a no-tech weekend, plan a getaway with friends and family, or book a spa staycation. Whatever it takes for you to rest, recharge and reset, do more of that.
Making Your Tax Return Count
On the surface, these suggestions may not sound as exciting as spending your refund on an exotic vacation. They may not be as easy as just putting it into your checking account to cover routine expenses. But the peace of mind and financial stability that smart investing brings will reap benefits for years to come. Prosper offers products and services tailored to our client’s needs, whether you’re working to raise your credit score, apply for a personal loan, or consolidate your debt.
Prosper does not provide tax advice. You should consult your own financial advisor.
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Read more
- Learn how financially savvy people put their tax refund to work
- The 9 Best Ways to Use Your Stimulus Check
- Filing Taxes: What You Need to Know Before Tax Season
- Saving vs. Investing: What’s the Difference?
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