Tax season is in full swing and your returns are due April 15. More likely than not, you will receive a refund. According to the Internal Revenue Service, the average refund amount is $2,869. That’s no small chunk of change, and you’ve been tasked with deciding what to do with it.
Oftentimes, people will use their tax refund to pay their property taxes or other upcoming non-discretionary expenses. I recently spoke to an employee at an auto parts store who said there’s a noticeable uptick in customers bringing cars in to be fixed in the spring due to the refund money they recently received.
While there’s no harm in spending your refund on practical expenses, clearly, you should avoid depending on a refund to pay for essential needs. If the refund you actually receive isn’t as high as you expected or you owe one year, you may be scrambling to gather the money you need – not a very good plan.
But good news! If you’re wondering what you should be doing with your potential three grand refund, here are four things people in their twenties should consider.
1. Pay off student loans or credit cards.
Debt keeps you from building wealth. The faster you pay off your debts, the sooner you can start saving, investing and growing your wealth. Interest rates are creeping up so you will continue to pay more and more in interest if you keep a credit card balance month-to-month. Before you spend a dime on anything else, make sure you pay off your debts. You will have more left in the future to spend on anything you want if you pay your loans off now.
2. Build up your emergency fund.
Compiling three to six months of living expenses in a savings account allows you some financial breathing room in the face of life. If I could add one law to be taught alongside Newton’s Laws of Thermodynamics in school, it would be Murphy’s Law. At some point, anything bad that could happen will happen. While we try to avoid worse case scenarios, more often than not, they will occur – and at the least convenient time. Don’t be caught flat-footed. Be prepared with an emergency fund.
3. Save for a down payment.
If you have a homeownership dream, this is a great goal to set aside a large chunk of money towards. In addition to saving a bit every month, setting aside your tax refund will give you an extra boost to motivate you. When setting a savings goal for a down payment, plan for at least 20% of the home price to avoid mortgage insurance.
4. Contribute to a Roth IRA.
A Roth IRA is one of the most powerful wealth building tools, and your twenties is the best time to reap the benefits of contributing to one. Contributions to a Roth IRA are made with after-tax money, and the account grows tax-free, meaning you won’t pay taxes on withdrawals once you reach age 59 ½, when you are likely to be in a higher tax bracket. For 2020, the maximum you can contribute to an IRA is $6,000. Your older self will thank you and treat you to a very nice steak dinner if you maximize your contributions each year.
Lastly, remember that your tax refund is not a gift of free cash. It’s your hard-earned money. You just loaned it to the government, interest free, throughout the year only to have it returned to you now. Essentially, you missed the opportunity to use that money for something else during the year.
Although you may look forward to receiving your tax refund each year, it’s important to look at adjusting your W-4 to minimize your refund moving forward. If you live according to your budget, you’ll be able to put the new extra paycheck money to better use throughout the year.