It's that time of year again! Everyone now has their W-2s, 1099's, and various other documents, while the first of the completed returns are starting to pour in. Of the more than 140 million tax returns filed each year, around 75% of them result in a tax refund, and the average refund is more than $2,800, according to TurboTax.
Instead of running out to the mall and going on a shopping spree, or putting a down payment on a shiny new car, why not put your tax refund to work for you this year? Here are a few of the best ways to put your refund check to work for your financial health that you may not have considered.
Pay down high-interest debt first
One of the few situations where I would advise people to do something with their extra money other than investing is to pay down "bad" debt. For this purpose, I'll define "good debt" as those debts with lower interest rates than you can expect to earn on your investments. As an example, if you expect your stocks to grow at 8% annually, and you're only paying 4% on your mortgage and 5% on your car, those are OK.
What is not OK to carry are credit card debts, especially if you have the extra cash sitting around. Think about it this way: If you have $5,000 invested and are earning a return of 8%, but also have $5,000 in credit card debt at 24% interest, you are actually losing $800 per year by not cashing out and paying off the debt! Credit cards and other high interest debts absolutely must be paid off before your wealth-building strategy can be totally effective.
Get a jump start on your retirement
Assuming that you don't have any high-interest debt that needs to be taken care of, the best thing that you can do with extra cash from your tax refund is to max out your IRA contributions. I recently wrote an article comparing the two main types of IRAs, traditional and Roth, but the main idea is that either one is better than a regular brokerage account, because it allows your money to grow tax-free.
If you have an income portfolio of high-yielding stocks, the benefit here can be tremendous. A $10,000 investment in high-yielding (12% or so) stocks like mREITs compounded tax-free could mean an extra $115,000 in your pocket after a 30 year period.
Plan for an emergency
The third best thing you can do with your tax refund, after paying down bad debts and investing for your future, is to establish an emergency fund for any unforeseen expenses. It is true that in a tough spot, you can withdraw from your IRA, but it'll cost you.
Experts say that you should aim for six months' worth of living expenses (bills, food, etc.) in a separate, easy-to-access account. While this is a lofty goal and is not practical for many people, anything is better than nothing. It's very nice to have the peace of mind of knowing that you'll be just fine if you lose your job, have medical issues, or if any other emergency comes up. Having an emergency fund also protects you from racking up high credit card bills or tapping into retirement savings, which would start this whole cycle again!
Foolish final thoughts
My main point here is to make you think twice about running out and spending your tax refund check on a bunch of stuff. If you feel the need to treat yourself, use a small amount of your refund to buy something for yourself or your family, and then use the rest to elevate your financial health. It's the absolute best gift you can give yourself.
Of course, this is not an exhaustive list, and everyone's financial situation is different, but these are good ways to start putting your extra cash to work for you.
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