The IRS says about 82 million taxpayers have received an average refund of about $2,800. Although many love the concept of found money, a refund is really just the return of a yearlong, interest-free loan that you extended to Uncle Sam.
Before the financial crisis, Americans would use refunds to purchase a new toy, but according to Adobe Digital Index, taxpayers are likely to act more prudently these days.
If you’re caught up on your bills, here are some ways to spend your tax refund.
REPLENISH EMERGENCY RESERVES For one reason or another, you may have dipped into your emergency reserve funds over the course of the year. Uncle Sam’s refund check can help replenish the account. Ideally, those who are working should have six to 12 months’ worth of expenses in reserve, and those who are retired should have 12 to 24 months’ worth stashed away.
SAVE FOR A FUTURE EXPENSE Will you need to replace a car this year? Is there a looming tuition payment? After you have replenished your emergency reserve fund, start saving cash to fund these future expenses.
PAY DOWN CREDIT CARD, AUTO AND STUDENT DEBT Your refund is an excellent way to put a dent in outstanding debt. The bonus is that when you pay down debt, you are essentially earning a guaranteed return that is likely much higher than any investment available.
BOOST RETIREMENT CONTRIBUTIONS If you are still working and have access to an employer-sponsored retirement plan, like a 401(k), a 403(b) or a 457, increase your contribution amount for 2016. Because you have that 2015 refund in the bank, you can afford to absorb the extra money coming out of your paycheck. The 2016 pretax contribution limit for employer plans has increased to $18,000 and the limit for over-50 catch-up contributions is $6,000.
You can also use that extra money to get a jump on funding an IRA or a Roth IRA for tax year 2016 right now. The maximum you can contribute to a traditional and Roth IRAs is the smaller of: $5,500 ($6,500 if you’re age 50 or older) or your taxable compensation for the year. Note: Even if you have an employer-sponsored plan, you may also qualify for the full annual IRA deduction. Check the IRS website for details.
INVEST IN A NON-RETIREMENT ACCOUNT If you have maxed out your retirement accounts and still have extra money, consider opening a non-retirement investment account with a no-load mutual fund company like Vanguard, T. Rowe Price, Fidelity or a discount brokerage firm like TD Ameritrade or Charles Schwab. Try to stick to low-cost index funds — a Morningstar study found that actively managed funds lagged their passive counterparts across nearly all asset classes, especially over a 10-year period from 2004 to 2014.
FUND 529 PLANS Is someone in your family struggling to save for college? It’s not surprising since the cost of college tuition has spiked 300 percent since 1990. If you are interested in giving the gift of education, then consider funding a 529 college savings plan. The money you deposit in a 529 plan grows tax free, and withdrawals that are used to pay for qualified college expenses sidestep taxes, too. You can invest up to $14,000 in 2016 without incurring a federal gift tax.
BE CHARITABLE You need not wait until December to be philanthropic. If you itemize your deductions, Uncle Sam will reward you next year.
Of course, if your financial house is in order, it really is OK to blow the refund and have some fun too!