Wondering What to Do With a Tax Refund?

Ah, tax season. For some of us, it’s a mad scramble to gather up receipts, 1099s, W-2s, and all of that mail that has “Important income tax documents enclosed” stamped across the front. Meanwhile, you might start Googling “free tax prep” or frantically emailing our tax professional about tax credits, refund checks, tax deductions, and deadlines. Turns out, adulting requires a surprising amount of accounting lingo.

Others—mythical beings out there—already have all of that stuff organized, and are probably busy trying not to gloat about their magical (and inspiring) income tax return preparation powers. Regardless, there are taxpayers in both camps who are asking the golden question: what to do with a tax refund.

While it always feels good to get a little something back from the IRS, getting too much back is a tell-tale sign that it may be time to adjust your withholdings for a more accurate federal tax return next year. However, if you’re looking forward to a refund this tax year, let’s talk about what to do (or what not to do) once that direct deposit hits your bank account. 

What to do with a tax refund 

A tax refund from the IRS can feel like “found” money, the grown-up version of discovering coins in your couch cushions. Even though it’s just an income tax over-payment, it’s tempting to treat it as a windfall. And that’s fair—after all, a vacation, wardrobe update, major home improvement, or new gaming system is more fun than “more responsible” options, but they’re not necessarily the most spendful options. 

If you want to prioritize short-term fun with your refund amount, by all means go for it! But this could also be an opportunity to set yourself up for more long-term peace and even more joy along the way. Here are four ways to get the most out of your tax refund: 

1. Pay down debt

Let’s be real—paying for stuff you’ve already bought doesn’t provide the same little rush of endorphins that buying new stuff does. It may be good advice from a personal finance perspective, but I’m not about to try to sit here and convince you that sending in a credit card payment beats the unboxing high that comes with a new purchase. 

But hear me out: debt weighs you down. Every dollar committed to past priorities is a dollar that’s unavailable for your future dreams and visions. What opportunities could you pursue if you were debt-free? No monthly payments of any kind? 

Could you travel more? Quit your boring job to do work that excites you? Fulfill your dream of becoming self-employed? Sleep better at night without the stress of impending emergencies and expenses? 

Debt costs more than just the interest accrued—there’s opportunity cost, as well. If you’re wondering what to do with a tax refund, consider the true costs of your debt. Choose the credit card or loan with the highest interest rate and send your refund in that direction to buy yourself some breathing room. 

Experiment with YNAB’s Loan Planner tool to see exactly how much that extra payment will save you in terms of time and money. 

2. Start an emergency fund 

According to a Bankrate survey, 41 percent of Americans couldn’t cover a $1,000 emergency expense with the money in their savings accounts. Maybe this is my own bad luck talking, but the likelihood of a $1,000 emergency seems pretty high. (And by the way, did you know that 93% of YNABers say they can cover a $1,000 emergency? Not too shabby!)

By definition, emergencies are pretty stressful. Add not being able to pay for one, and you’ve got a potential avalanche of anxiety.

Use your tax refund to build up your emergency savings and protect yourself against life’s uncertainties. Create a category in your spending plan called “Emergency Fund” and allocate that number of dollars to it. Or, even better, be more detailed. A generic emergency fund is helpful, but allocating money to specific non-monthly bills and expenses makes things that you used to consider emergencies feel routine. You’ll gain more peace of mind and make sure you’re saving just the right amount.

YNABers get a rush from the peace of mind that fully-funded emergency categories provide. We have a YNAB template for that.

3. Get a month ahead

Imagine if on the first day of next month all of your bills and expenses were fully funded with real money you have in the bank right now? You wouldn’t even need to use your next direct deposit for weeks. How much peace would that give you? How would that change how you make decisions? That’s the idea behind YNAB’s resilience question: What can I set aside for next month’s spending? 

It plays out like this: get a bill, pay it with money you earned last month (or the months before that). Get a paycheck, and put it in the bank for safekeeping until at least next month. The theme is that you don’t need the money that comes in today. If that sounds like an impossible dream, remember that you just got an income tax refund, and then read these 10 ways to get a month ahead of your expenses. 

4. Invest in your future the smart way

Finally, if you’re debt-free and cash is no concern, it might be a good time to start investing! Cue the confetti. Future you is already celebrating.

Let tax return season be the time you finally stop letting those unused dollars languish in your savings account! Move them to a carefully-invested Roth IRA, 401k, or other retirement account instead. 

Giving your dollars the job of recruiting more dollars can help you ramp up your wealth over time. And it’s not just about retirement savings. Investing can give you the freedom of choice—whether it’s quitting your job, paying for your child’s college tuition, becoming self-employed or committing to that home improvement you’ve always wanted. Why not start with your tax refund?

If you’re new to investing and retirement plans, check out Invest Like a Pro for Jesse’s advice on how to get started the smart way.

The decision is yours

Living a spendful life means taking care of yourself: past, present, and future. Whether you use your tax refund to pay down debt, boost your health or happiness, or set yourself up for a sweet RV life in retirement, it’s all about being clear on your priorities.

While it might be tempting to buy the fancy area rug that you’ve had your eye on (it would really tie the room together, right?) or take off for an impromptu weekend trip, consider the power of your intention… and use that tax refund money to support the things that will generate the most (true) happiness for you!

Ready to gain total control of your finances by putting your tax refund to work? Try YNAB for free for 34 days.