Lisa Whitley — It’s that time of the year when thoughts turn to…income tax refunds. And more specifically, how you might use that refund. According to the IRS, the average size of a federal tax refund for the 2019 filing year was $2,841. For many households, a tax refund is one of the most important “forced” savings mechanisms in their financial plan. (And before you get all riled up about how this is an interest-free loan to the government, bear in mind that at today’s rates the average household likely “gave up” less than $1 in interest.)
Step back and think about your goals for 2021. What felt good and what felt not-so-good about your finances in 2020? How do you want your financial life to progress this year? With that perspective, let’s review some of your choices:
- Add to your emergency fund. If your emergency fund totals less than 3 months of expenses, your tax refund should go here even if you are carrying credit card or other costly debt. And depending on your situation, a 3 month emergency fund may not be enough for you to feel secure.
- Pay off high interest debt. But if your emergency fund is in place, this is definitely your next port of call for that tax refund.
- Add to your “sinking fund.” Aside from your emergency fund, have you set aside money for expected, but infrequent, large expenses that will come along in 2021? Some of these are rather dull (car insurance, property taxes, a new appliance, medical expense, etc.), but some may be quite welcome (a vacation — finally, or a contribution to a future house down payment).
- Boost your retirement account. Why not show your future self a bit of love and deposit that check to a Roth IRA account?
If saving your refund is the plan, don’t let that resolve disappear between the time you hit submit on your completed return and the day the deposit arrives at your bank. Using IRS Form 8888, you can split your refund direct deposit into different accounts. You can even deposit your refund directly to an IRA or Health Savings Account. (For your IRA, be sure that you understand to which tax year your financial institution will assign the contribution.) And don’t forget the option of using your refund to buy Series I savings bonds directly.
Whichever path you choose, make sure that your refund decision is a deliberate one that supports your financial health in the new year!