Ask the Experts: I’m expecting a large income tax refund—what should I do with it?
If you’re anticipating a sizable federal income tax refund, you’re not alone. According to the Internal Revenue Service, over 100 million individuals received federal income tax refunds last year, and the average refund check exceeded $2,000. How you spend your refund check is up to you, but before you call a travel agent or splurge on a new plasma television, consider whether there might be better ways to put this sum of cash to work for you.
For example, if you have outstanding credit card balances, give thought to applying some or all of your refund toward these balances, starting with the credit card that carries the highest interest rate. Consider this: Applying $2,000 toward a credit card with an APR of 14.9% (instead of letting the $2,000 accrue interest for a year) could save you almost $300. If you don’t have outstanding credit card balances, think about using your refund dollars to pay down other high-interest debt.
Alternatively, consider saving or investing the funds. A sudden infusion of cash, particularly if it’s unexpected, can provide the perfect opportunity to start an education fund for your children or grandchildren. And investing funds in a tax-advantaged savings vehicle like a 529 plan today can pay off handsomely in the future. For example, if you contribute $2,000 today to a 529 plan or a Coverdell education savings account for your 2-year-old child, assuming a 6% annual rate of return, your $2,000 will have grown to $4,793 after 15 years. If you’re eligible, also consider the benefits of using your refund dollars to contribute to a Roth or traditional IRA.
In the end, it’s your money, and your decision. If you want to splurge, go ahead. Just try not to spend on impulse. And keep in mind that there’s no rule that says you have to spend it all. One idea is to spend half your refund dollars, and to invest or apply the balance.