5 Great Ways to Spend Your Income Tax Refund

Make the most of your income tax refund, as it can do a lot of good.

Aug 31, 2014 at 6:30PM

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Take advantage of the opportunities your refund represents. Photo: Hey Paul Studios via Flickr.

The average income tax refund received by Americans this year was roughly $2,700. That's a significant chunk of change, and the fact that it's an average means that plenty of people received significantly more. It's smart to have a good plan for how you'll spend your tax refund -- because it can make a big difference in your life.

Fill financial holes

For starters, do you have an emergency fund in case you suffer an unexpected crisis such as a job loss or major medical expense? Experts often recommend socking away three to six months' worth of living expenses, but think about what's best for you. If it's hard for you to land a new job, for example, perhaps sock away nine months' worth or more if you can.

Next, have you done any estate planning? A will can be prepared using software or some websites, but it's often best to spend some money on a lawyer, especially if your situation isn't simple. An estate-planning pro can also prepare living wills, durable-power-of-attorney forms, advance healthcare directives, and trusts.

Pay down debt

Another important expense to tackle is debt -- especially high-interest-rate debt. If you apply your income tax refund toward paying down $3,000 of credit card debt that is charging you 20% per year, for example, you'll avoid forking over $600 in interest! If you have no high-interest-rate debt, look at other obligations such as car or student loans. Or if you can make a penalty-free prepayment of $3,000 against the principal of a fixed-rate mortgage at 5%, that's like earning a guaranteed 5% return on that money.

Paying down debt also offers the extra benefit of improving your credit rating.

Invest in the future

Your income tax refund can also be used to invest in your future. The annual contribution limit for an IRA in 2014 is $5,500 for most people, plus a $1,000 "catch-up" contribution for those 50 or older. Applying a refund toward a retirement plan is a great way to improve your future. You might alternatively park the money in a 529 plan, which lets you save (and ultimately pay) for your kids' education expenses with untaxed dollars. A refund can help make your entrepreneurial dreams come true, too, representing seed money for a business you want to start. (And socking away four years' worth of refunds might net you $10,000 or more.)

Consider spending some of your income tax refund on professional financial-planning services. That can cost several hundred dollars, or even several thousand, but if a pro gets your money invested most effectively and helps you plan strategically to meet your financial goals, it can be well worth it. You can look up fee-only planners at www.napfa.org.

Invest in yourself

Investing in yourself is also a smart move for your income tax refund money. By taking a course or two, earning a new certification, learning a new language, or completing a professional development program, you can enhance your prospects at your current job -- or set yourself up to switch careers. You can also invest in yourself by applying your income tax refund toward a gym membership and improving your health and longevity. If your finances and fitness are in good condition, your refund can pay for travel, which can make you a more well-rounded person with cherished memories.

Invest in others

Finally, consider spending some or all of your income tax refund on improving the lives of others. We often forget that nearly 2 billion people live (or try to live) on less than $2 per day. The United States is a wealthy nation, but as recently as 2012, more than 46 million Americans lived in poverty (including 22% of all children under 18). There are countless worthy causes that could use your support. Finding a charity you believe in and donating wisely can make a big difference in the world.

Give some thought to how you might best spend your income tax refund -- and make the most of it.

Be tax-smart in another way -- via this little-known "loophole"
Recent tax increases have affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "The IRS Is Daring You to Make This Investment Now!," you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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