What To Do—and What Not To Do—With Your Tax Refund

So, you’ve got your tax refund – should you save or should you splurge?

The average tax refund so far this year is $3,034, an increase of 5.6% from 2014, according to the IRS. While you may be tempted to go on an all-out shopping spree or take a trip to the Caribbean, there are probably better ways to spend your cash.

What to do with your tax refund

1.      Pay off credit card debt
Paying off your high-interest credit card debt early is one of the best investments you can make.

Let’s say you currently have a credit card balance of $3,000 at an annual percentage ratio (APR) of 14.99%.  By making a minimum $60 payment on the card each month, it will end up taking you 19 years to pay off the balance in full, and you’ll pay $3,906 in interest!

Instead, you can pay off the balance in full to save that $3,906 in interest immediately. Or, to pay off the balance in 1 year, you can make payments of $271 per month for a year.

If you have credit card debt on multiple cards, you should pay off the one with the highest interest rate first, then work on the next one.

2.      Pay off private student loan debt
If you’re feeling trapped by your student loans, it might be time to take some action.

Private student loans often have a higher interest rate than federal loans, so they should be paid off first. Many private loans also have variable rates, meaning that it’s possible the interest rate could go higher in the coming years.

Paying off your student loans in full won’t happen overnight. But using your tax refund to pay them off could help lessen the burden.

3.     Start an emergency fund
A good rule of thumb is to have at least three to six months of living expenses in a savings account in case of emergencies. So if your total expenses are $2,000 a month, you might want to plan to have at least $6,000 in savings.

This fund could go towards things such as rent, food, clothing, gas, auto repairs and emergency medical expenses. It also acts as a safety net in case you lose your job. Having an emergency fund is a smart idea and now might be the best time to start one.

4. Start a Roth IRA
It’s never too early to start thinking about retirement.

A Roth IRA is a retirement account that offers tax-free distributions at retirement. While a traditional 401k allows you to invest pre-tax money, you are taxed when you make your withdrawal. With a Roth IRA, you are investing post-tax money, but receiving a significant tax break at retirement, as you will withdraw your money tax-free.

There are a few rules: both a Roth and a traditional IRA have an annual contribution limit of $5,500 per year, or $6,500 if you’re 50 and older.

For a Roth IRA, your adjusted gross income must be under $191,000 to contribute anything if you are married and under $129,000 if you are single.

 A traditional IRA includes deduction limits, or the amount of your contribution that can be deducted from your paycheck before taxes. The maximum limit you can contribute to a traditional IRA is based on your adjusted gross income and whether or not you are covered by a retirement plan at your job.

 5. Have some fun
Life can be stressful, so it’s always important to relax and have some fun!

You may want to consider taking out 5-15% of your refund for fun. If you’re going to buy something nice for yourself or go on vacation, it’s better to use the cash you have now, rather than using your credit cards. Pick a percentage that you feel is right for you, but wait to spend until after you attend to any outstanding bills or balances.

6. Start an Online Brokerage Account
If you’ve got a healthy emergency fund and have the extra money, why not start an investment portfolio? Investing can help you grow your money more quickly than a savings account.

Before you start investing, you need to ask yourself what types of investments you want to own and what your risk tolerance is. Your investment choices include individual stocks, mutual funds, exchange-traded funds (ETFs), bonds and CDs.

If you are looking for the highest possible returns, you may want to choose individual stocks – just understand that you’ll be taking on the most risk.

If you want to be more conservative, you can opt for an ETF or a mutual fund instead. When choosing an individual ETF or mutual fund, some things you’ll want to look at are the long-term performance of the fund, the performance against major indexes, how long management has been in place, what individual investments or stocks make up the fund, and the fund’s expense ratio.

What not to do with your tax refund

1.      Hit up the casinos
With $3,000 in your pocket, you may be tempted to hit up the blackjack tables in Vegas, or go out and buy hundreds of lottery tickets. But using your tax refund to gamble is not a wise move.  It’s one thing to take $300 to the casino and have some fun; it’s another to blow $3,000 in one night. Remember that with gambling, the odds are always against you.

2.      Take on a financial obligations you can’t afford
Just because you have a few thousand dollars doesn’t mean you can afford a new car, a new home or a swimming pool. Make sure you can actually afford these purchases over the long run, or you could end up in a worse financial position than you were in before.

3.      Splurging on “Stuff”
$3,000 can buy plenty of nice clothes, a new flat screen television, new furniture, and more – but do you really need all of this stuff? Just remember that most of the time, the feelings of joy that these things can bring to us dissipate very quickly.

Steve Nicastro, NerdWallet

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