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by Holly Johnson
February 14, 2018
by Holly Johnson
February 14, 2018
In 2017, the average individual who received a tax refund for the year before got a cool $3,050 of their federal taxes back. That's a lot of money, and perhaps a life-changing amount of cash in some instances. On the other hand, what people do with that money determines whether it helps them build wealth — or simply scratch a fleeting consumer itch.
Think about it: With $3,050 in the bank, you could splurge in ways that don't really affect your bottom line either way. You could buy a basic hot tub for your back deck, pay for an all-inclusive vacation to the Caribbean, or piss it away on clothes and whatever else you desire.
On the flip side, you could spend your tax refund in ways that actually leave you worse off. You could put $3,000 down on a brand new $35,000 truck that saddles you with a $600 monthly payment, for example. You could put that money down on a boat you always wanted – a boat with costly repair bills and a value that literally sinks overnight.
If you want to gain some real momentum with your finances in 2018, it's smart to start thinking about your tax refund early. With several thousand dollars potentially coming your way, what's the best way to make that money count?
Instead of spending that cash infusion in a way that leaves your finances neutral or even worse off, consider these tried-and-true savings strategies that will improve your finances no matter what:
High-interest debt is one of the biggest hurdles to overcome if you want to build wealth. When you owe money on credit cards or carry personal loans with high interest rates, it's difficult to get ahead when so much of your payment goes to interest only.
Here's the good news: Throwing $3,050 (or whatever your tax refund amounts to) toward high-interest debt will always leave you better off. Making an extra payment toward the principal of your credit card or loan balances will help you save on interest automatically while moving your debt payoff date that much closer.
Just how much can you save? Imagine you have a $3,050 credit card balance at 18% APR and you have the opportunity to pay it off in one fell swoop. If you used your tax refund to repay this debt, you would save yourself almost four years of monthly minimum payments, and a whopping $1,210 in interest payments alone.
Whether you carry some high-interest debt or live a debt-free lifestyle, building an emergency fund is essential for your financial health. Without an emergency fund, you're prone to struggle if you face unexpected financial emergencies like surprise medical bills, expensive home repairs, or a layoff.
Ask yourself how long your money would last if say, you lost your job this week or you could no longer work due to an injury or illness. With no emergency fund, your savings would likely dwindle and you might even need to use credit to stay afloat. With a healthy emergency fund, on the other hand, you'd have time to figure things out.
While most experts suggest you stock an emergency fund with at least three to six months of expenses, even a smaller amount is a good place to start. Saving $3,050 now can even turn out to be life-changing later on if you find yourself in a situation where you're suddenly desperate for cash.
If you have a savings account, consider adding your tax refund to the pot. If not, open a high-interest savings account and start funding it today.
A health savings account (HSA) is a tax-advantaged savings account set up specifically to pay for healthcare costs. Once you open this account, you'll be able to deduct contributions up to a certain limit, watch your money grow tax-free, then use your funds for qualified healthcare expenses on a tax-free basis. And if you don't use up your HSA funds by the time you turn 65, you can withdraw funds for any purpose – even to pay for retirement.
The myriad tax advantages this account offers are the reason it's commonly referred to as the best retirement plan you've never heard of. HSAs are helpful when it comes to saving for healthcare expenses, but they may be even more advantageous for retirement.
Either way, individuals can contribute up to $3,450 and families can save up to $6,900 in an HSA account in 2018, provided they have a high-deductible healthcare plan. The IRS defines high-deductible plans as those with a minimum deductible of $1,350 for singles and $2,700 for families. Maximum out-of-pocket amounts on qualified plans are also limited to $6,650 for individuals and $13,300 for families in 2018.
Even if you contribute to a 401(k) or another type of employer-sponsored retirement account, you may also be able to add money to a traditional or Roth IRA. Both traditional and Roth IRAs are easily opened online and simple to use and understand.
The big difference between them is that traditional IRAs allow you to contribute pre-tax dollars and deduct your contributions if you meet certain income requirements. Roth IRAs, on the other hand, let you contribute after-tax dollars and allow you to take tax-free distributions when you retire. Roth IRAs also have income limits that make it harder for high earners to contribute.
If your emergency fund is in good shape and you don't have a lot of high-interest debt, opening one of these accounts or adding to an existing account could be a smart move.
Just keep in mind that, for 2018, your total contribution to both a traditional and Roth IRA cannot exceed $5,500 (or $6,500 if you're ages 50 and older).
If you have competing financial goals and want to save for all of them, starting several different savings accounts can be a smart move. Maybe you want to update your kitchen within the next few years, but you also want to save up for a newer car and a summer vacation. By starting a few different accounts, you could give yourself a head start toward achieving everything you desire.
You could spread your tax refund across several accounts for starters, then commit to weekly or monthly contributions so each savings bucket will grow. Just make sure you stash your cash in a high-interest savings account so you can earn at least a little interest on your deposits.
Maybe you're already invested in your workplace retirement plan or an IRA, and want to try something new. There are many other worthy to invest, so you could always open a brokerage account and invest separately from your retirement funds. The best online stock brokerage firms for 2018 make it easy to learn investing basics online, start investing with small sums of money and do it all without excessive fees.
Beyond opening a brokerage account, there are other investing avenues to consider as well. If you're saving for college, a 529 plan is an obvious choice. Riskier alternative investment options might include investing in peer-to-peer lending with a company like Lending Club or Prosper, in real estate notes with a firm like Fundrise, or even in small amounts of cryptocurrency if you can handle the volatility.
At the end of the day, any way you can learn more about investing while also growing your wealth is probably a good thing.
Finally, don't forget about the most important asset you'll ever have – yourself. If you receive enough cash in your tax refund to invest in anything, spending that money to improve yourself or your life may pay off more than anything else.
Fortunately, there are a ton of ways to invest in yourself – and some of them don't cost a dime. You could invest in your mental and spiritual health by meditating, getting a good night's sleep, or exercising regularly, for example.
In terms of financial investments, there are a ton of ways to use $3,050 (or any other amount) to your advantage. You could pursue an advanced certification that makes you more valuable to your employer, for example. You could take a course in a subject that interests you, purchase the start-up equipment or software needed for a side business, or invest in continuing education that could leave to higher pay and better job security in your current career path.
Any investment you make in yourself will likely pay off in the short term and over the course of your life and career. So, once your other financial ducks are in a row, don't forget to spend your money where it counts – on self-improvement.
Whether you receive $500, $3,050, or considerably more in your tax refund this year, it's up to you to put this cash to good use. You can use it to splurge on something you've always wanted, or you could invest it in a way that could make you richer in the long run.
And, if you can't decide which way to go, maybe you should do a little of both. Buy something you want for sure, but stash the rest of your cash away for a rainy day. While it's hard to do the right thing when you receive a windfall, your future self will thank you.
Holly Johnson is an award-winning personal finance writer and the author of Zero Down Your Debt. Johnson shares her obsession with frugality, budgeting, and travel at ClubThrifty.com.