Coming into a windfall is rare. But for some, it happens every year — in the form of a tax refund.
The IRS issued more than 100 million refunds last year, averaging a little less than $3,000 apiece.
Yes, the average check may be somewhat smaller this year, but it’s still a relatively nice chunk of change considering that even an unexpected $1,000 expense, such as an emergency room visit or car repair, would push many Americans into debt.
A refund offers a rare opportunity to improve your financial standing, according to Corey Carlisle, executive director of the American Bankers Association.
“Prioritizing your tax refund to create an emergency fund and pay off debts first will help position you for financial comfort the rest of the year,” Carlisle said.
“As those who have been affected by the federal government shutdown this year can attest, financial challenges can arise quickly and it’s critical to have money set aside for those unexpected hardships,” Carlisle added.
To put this money to good use, the ABA offers the following tips:
• Save for emergencies. About 40 percent of adults said that if faced with a $400 unexpected expense, they would either not be able to pay it or would do so by selling something or borrowing money, according to the Federal Reserve.
You can better prepare by opening or adding to a savings account that serves as an emergency fund. Ideally, it should hold about three to six months’ worth of living expenses in case of sudden financial hardships such as losing your job or having to replace your car, but even one month is a start, Carlisle said.
“You never know when you’ll have to tap into the those funds,” he said.
• Pay off debt. Total credit card debt is at its highest point ever, surpassing $1 trillion, the Federal Reserve also found. The average American has a credit card balance of $4,293, according to the latest Experian data.
Start by figuring out what you owe, then decide whether to use the “debt avalanche” or “debt snowball” method to chip away at those revolving loans.
The avalanche method lists your debts from highest to lowest by interest rate. That way you pay off the debts that rack up the most in interest first.
Alternatively, the snowball method prioritizes your smallest debts first, regardless of interest rate. The idea is that you’ll gain momentum as the debts are paid off and that will motivate you to keep going.
• Save for retirement, education or future health expenses. This is a great opportunity to open or boost contributions to a 401(k) or individual retirement account — helped, in part, by the new, higher limits for 2019.
For those with school-aged children, look into opening a tax-advantaged 529 college savings plan.
Alternatively, get ahead of health-care costs by investing tax-free dollars in a health savings account, or HSA, Carlisle advised.
• Pay down your student loans. Putting an extra payment toward your student loan tab will save money on interest and reduce the length of your loan.
Specify that those extra funds get applied to the principal of the loan and not to future interest payments. (However, if you have unpaid fees, the money must be applied there first.)
You can even try the same trick on your mortgage by making a 13 payments a year instead of 12.
“For those who want to retire debt-free, this might be an opportunity to reach that goal a little faster,” Carlisle said.
• Buy savings or municipal bonds. Rather than having the refund deposited into your checking account, you can elect to use that money to purchase bonds at face value through the U.S. Treasury by submitting Form 8888.
“You’ve been giving the government an interest-free loan, this is an opportunity to get some return,” Carlisle said.
• Invest in your home. A home improvement project is another way to reap a return from those hard-earned dollars by increasing the value of your home in the long run, with the added benefit of giving you some enjoyment in the near term.
This can include small, cost-effective upgrades such as energy-efficient appliances or new windows, Carlisle suggested.
“Sometimes it’s nice to see an immediate return,” he said.
• Donate to charity. Giving back is, of course, an additional example of money well spent. Putting your refund toward the charity of your choice will not only make a difference in your community, but you can also claim the tax benefit on next year’s return, if you itemize.
(To surpass the new, higher standard deduction, donate every two or three years instead of every year by using a donor-advised fund, which lets you make a charitable contribution and receive an immediate tax break for the full donation, and then recommend grants from the fund to your favorite charities over time.)