These Are the 3 Best Things to Do With Your Tax Refund

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  • Many Americans will receive a large tax refund this year.
  • This lump-sum payment presents a great opportunity to improve your finances.
  • Paying off debt, building an emergency fund, and investing are a few smart ways you can use your tax refund.

Make sure you use your tax refund wisely.

Many Americans get back thousands of dollars from the IRS after filing their tax returns. The lump-sum payment that comes from a tax refund presents a great opportunity. Rather than spending the money on purchases that won't pay off in the end, you can use the funds to improve your long-term financial situation.

While there are lots of ways you can put your refunded tax money to good use, here are three of the best things to do with the cash the IRS sends you.

1. Pay down debt

If you have high interest debt such as credit cards or payday loans, you can use your tax refund to pay as much of your debt back as possible.

By making a large payment, you can reduce your principal balance. That will reduce the interest you pay over time and get you closer to becoming debt free for good.

2. Shore up your emergency fund

An emergency fund helps you to avoid financial disaster if you face unexpected expenses or a loss of income. When you have money saved for emergencies, you have a financial cushion so you don't have to borrow if you face a surprise cost you didn't plan for in your budget. If you lose your job, receive big medical bills, or can't work because of illness, you can use the money you've saved to cover the bills so you don't face foreclosure, repossession, or other serious consequences.

Unfortunately, many people have too little saved for emergencies. The standard recommendation is to have three to six months of living expenses set aside, but it's common for people to have far less -- or even nothing saved at all.

A big tax refund allows you to start an emergency fund or bulk yours up if it's too small. By becoming better prepared for unpleasant surprises, you'll have more peace of mind and a more secure future.

3. Invest for the future

If you don't have high interest debt and your emergency fund is fully funded, then investing for long-term financial goals can be a great use of your tax refund.

You can do this in a few different ways. If you're saving for a big purchase, such as a home down payment, you can deposit your refunded money directly into your savings account. You could also contribute the money to a tax-advantaged retirement plan, such as an IRA with a brokerage firm.

By investing for retirement in a plan that comes with tax breaks, you can actually lower next year's tax bill with this year's refund.

Which option is best for you?

Ultimately, the best place to put your tax refund will depend on your current financial situation.

The important thing is to consider how you can leverage this money to grow your net worth in the best way possible, based on what you currently owe and what your current and long-term financial goals are.

You can't go wrong with any of these three suggestions, so think about which one will make the biggest impact so your refund can benefit you for a long time to come.

Ready to file? Check out The Ascent's list of the best tax software.

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