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7 Money-Smart Ways to Spend Your Tax Refund

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7 Money-Smart Ways to Spend Your Tax Refund

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The average federal tax refund so far this year is $2,772 – about the same as the average for 2019. But what a difference a year makes. Instead of using the money for a summer vacation, many people who have lost their jobs because of the coronavirus pandemic will need to use their refunds to pay the mortgage or buy groceries.

If you're fortunate enough to have the essentials covered, you may be tempted to treat yourself to takeout from your favorite restaurant or a nice bottle of wine. Fine. But once you've scratched that itch, consider these ways to put the rest of your tax refund to work for you.

ways to spend your tax return
Shore up (or start) your emergency fund

Even if you're working now, there's no guarantee your hours won't be cut, your salary reduced, or your job eliminated. That means it's more important than ever to have money set aside for emergencies. That way, you won't have to run up credit card debts or raid your retirement savings to pay the bills until you get back on your feet.

Aim for six months of living expenses – more if you're the sole provider for your family. Interest rates are abysmally low right now, but you can eke out higher rates by putting your savings in an online bank account. Look for one with no minimum balance requirement or monthly fees.

Pay off high-interest debt

While interest rates have been falling, most credit cards still charge upwards of 15%. Pay off those unpaid balances and you’ll get a return on your investment a successful hedge fund manager would envy. If you’re able to pay off the entire balance, you’ll also eliminate a monthly expense, which will give you some breathing room if you lose your job.

Support a worthy cause

Food banks have been overwhelmed in recent weeks, and other nonprofits that provide social services to people in economic distress are also stretched to the limit. Donating some of your tax refund will help them fulfill their mission, and you'll get a modest tax break, too. To encourage more charitable giving, the CARES Act, which was signed into law earlier this year, includes a provision that allows taxpayers to claim a new "above-the-line" deduction on their 2020 tax return for up to $300 in cash donations. Contributions to donor-advised funds don't qualify for this tax break, though.

If you itemize, the amount you can deduct for cash contributions is usually capped at 60% of your adjusted gross income (any cash donations over that amount can be carried over for up to five years and deducted later). However, the CARES Act lifts the cap for cash donations made in 2020. As with the new above-the-line deduction, donations to donor advised funds don't count.

Invest in a 529 college savings plan Contributions to a 529 college savings plan grow tax-free, and withdrawals aren't taxed if you use them for qualified expenses, such as college tuition and room and board. You can invest all or a portion of your tax refund – 529 plans typically have very low minimums. Plus, your state may give you a tax deduction or credit if you invest in your own state's plan. If your children are young, you have many years for investments in the plan to compound and grow. To research plans, go to savingforcollege.com.
Protect yourself from unexpected health care costs

If you have a high-deductible health insurance plan (a deductible of at least $1,400 for single coverage or $2,800 for family coverage), you can contribute to a health savings account. An HSA gives you a triple tax break – your contributions are tax-deductible (or pretax if through your employer), the money grows tax-deferred, and you can use it tax-free to pay out-of-pocket medical expenses in any year (there's no use-it-or-lose-it rule).

The CARES Act increased the types of eligible expenses for tax-free withdrawals from your HSA. In addition to health insurance deductibles, co-payments, prescription drugs and medical expenses that aren't covered by your insurance, you can use tax-free withdrawals to pay for most over-the-counter medications and feminine-hygiene products. Although health-insurance premiums are typically not considered qualified medical expenses, there's an exception if you use withdrawals to pay COBRA premiums or for other health-insurance premiums if you're collecting unemployment benefits.

Protect yourself from natural disasters

Consider using your refund money to protect your home. A home generator will keep the lights on and the food cold during a power outage. A 6.5 kw portable home generator costs about $800 to $1,000. You can also use the money to pay someone to trim your trees, which will help protect your home from some of the most common types of storm damage.

Upgrade your home office

If the COVID-19 pandemic has you working from home, you're probably well aware by now of the inadequacies of your home office. Use your refund to buy a standing desk. Is your back acting up? Maybe you need a new chair with a contoured seat cushion that's designed to relieve pressure on your legs.