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10 Smart Ways to Spend Your Tax Refund and How to Protect Your Future Income

10 Smart Ways to Spend Your Tax Refund and How to Protect Your Future Income

woman looking at tax paperwork

For many Americans, a tax refund is a time for celebration. You get a chunk of bonus money from the government. But what many people don’t realize is that the money was yours to begin with. A tax refund means that you overpaid your taxes and the IRS is returning to you the amount you overpaid.

Either way, receiving a refund still feels like receiving a bonus. And, if you’re smart, there are a number of ways you can spend that tax refund to protect your future income. We talked to a some experts and they shared a few creative ways to spend and invest your tax refund that will work to your benefit.

1. Invest in a New Business

If you’ve always dreamed of operating your own small business, tax time could be the right time. According to Forrest McCall, owner of the finance blog Don’t Work Another Day, “There are many small businesses and side hustles that you can start for less than a couple thousand dollars, providing an immense opportunity for those willing to give it a try. Because there are so many options, there’s sure to be an idea for just about anyone.”

Starting a business or side hustle with your refund money can help you diversify your income in the case of a job loss or other financial emergency. Start planning now, and when you receive your tax refund, you’ll know how to use that money to invest in your new business or side hustle.

2. Invest in Reskilling

For most people, when they think about investments, they think about buying stocks or bonds. But, there’s one big area they forget about: human capital.

Use your tax refund to invest in yourself and learn a new skill. “Individuals need to put aside money in their emergency fund to provide for the contingency of paying to reskill,” says Harry N. Stout, founder of FinancialVerse Organization. “There are no specific insurance products that can be purchased to pay for this risk. That is why emergency savings have to be the funding source.”

You are one of your biggest assets and the job and pay you usually comes down to the skills you have. Invest in reskilling yourself by paying for additional training, tuition, a conference ticket or a professional membership. This can improve your value in the job market and pay off for years to come.

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3. Start an Emergency Fund or Refill Your Savings

For many of us, 2020 wasn’t kind to our savings account. Having cash on hand to pay for an emergency can help you sleep better at night. When you receive your tax refund, assess your emergency fund and savings to see if you need to top them off.

An ideal emergency fund will hold enough money to cover three months of living expenses. But, if you’re just starting to build your emergency fund, even $500 can go a long way. The first step is to bring your savings or emergency account above zero.

4. Pay off High-Interest Debt

If you have debt, a tax refund can be a nice chunk of money to help you pay down debt. The first thing to do is to assess the type of debt you have. High-interest debt is generally considered bad debt and should be paid off first.

Mason Miranda, Credit Industry Specialist at Credit Card Insider, suggests: “Pay as much as you can on the loans with the highest interest rates first and continue making minimum payments on the rest. This is considered the Avalanche Method of debt repayment and will save you the most money when paying off debt.”

Putting your refund money towards debt can improve your finances and help build up your credit score as well.

5. Reinvest to Grow Your Business

The year 2020 was difficult for most small businesses. If you operate a small business, you may have had to reduce unnecessary spending and cut costs throughout the business. If you receive a tax refund, consider reinvesting it in your business. “This can help alleviate cost-cutting efforts that many businesses have attempted in the past year,” says Forrest.

A wise choice could be to spend on advertising and marketing to help you grow your customer base or buy a piece of equipment that will help you offer customers a better product.

6. Spend on Home Improvements

Another smart way to spend your tax refund is to invest it in your home. If there’s a home renovation you’ve been saving up for or upgrade you want to do, your tax refund is a great way to contribute a chunk of money to that project. Investing in your home can make it more enjoyable to live there and it can raise your home’s resale value.

7. Invest in Something Frivolous

So far all of the smart ways to spend your tax refund have been about investing or reinvesting the money in something that will pay dividends in the future. But, that’s not the only way to enjoy your tax refund. You can also just…spend it!

R.J. Weiss, CFP and founder of The Ways to Wealth, suggests, “Set aside part of your tax refund, no more than 10 percent, to reward yourself. Spend it on something you likely wouldn’t have. Take the weekend trip, update your wardrobe, go out to a nice dinner. Then, allocate the rest responsibly, such as paying off debt, putting it in an emergency fund or investing it.”

Taking a small portion of your money and spending it on something frivolous can bring you a large amount of joy. Treat yo’self.

8. Set Your Children Up for Financial Success

If you’re feeling financially secure, a great way to use your tax refund is to set your children up for financial success and a secure future. You can transfer your tax refund into a UTMA (Uniform Gift to Minors Act) custodial account for your child.

“By opening this type of account, not only will you safeguard the future goals of your child (whether it’s a first car or a down payment on a house), you can use it as an educational tool to teach children smart money-management habits,” says Ksenia Yudina, CFA, founder and CEO at UNest.

9. Invest in Upskilling

According to Harry, upskilling “is the proactive action taken to add better skills such as stronger technology or project management abilities that produce higher personal productivity and better job performance. In short, workers become more skilled employees qualifying for higher compensation.”

By investing in upskilling your job skills, you can become a better employee, earn a bonus and potentially move into a higher-paying job.

10. Pay It Forward

Do none of the above ways to spend your tax refund work for you? Here’s one more: donate it. If you don’t have a need and aren’t interested in spending it on yourself, you can pay it forward to a cause that’s meaningful to you. Donating your tax refund helps those in need supports a cause that’s important to you and it might just give you those warm fuzzy feelings.

The IRS will soon be sending out those tax refunds, so take the advice of these financial experts and make a plan on how you want to spend that chunk of money you get back. Your tax refund is yours to spend and there are many smart options for how to spend it that will help to protect your financial future.