Why and How To Save That Tax Refund

Have you thought about what you’re going to do with your tax refund? According to a GOBankingRates survey, more than half of Americans plan to save and invest it, while only 10 percent want to use it for a vacation or luxury purchase.

Getting a large sum of money returned to you all at once might feel like a great excuse to treat yourself, but it could also be an opportunity to get ahead of your finances and caught up on debts.

Here’s why you should consider saving your tax return and how you can make it worth your while.

Why Save?

Simply put, it’s your money, so you shouldn’t be in a rush to give it away.

It’s tempting to view your tax refund as free money from the government, but the return is actually the government’s repayment of a no-interest loan you made. In other words, any extra money you’ve given the government via your paychecks is simply coming back to you at a later date. The more money withheld from you during the year, the larger your refund. The withheld amount depends partially on the number of allowances you entered on the W-4 document you submitted to your employer.

Whether your financial issues are big or small, when money that rightfully belongs to you comes back, saving it to pay off important bills or investing it so that it can grow is a more practical choice.

How You Can Save Your Tax Refund

There are all kinds of ways you can save and use your refund to grow financially.

Pay Off Debt

According to ValuePenguin, the Northeast and the West lead the nation in having the highest credit card debt average – over $8,000 worth. A different study shows New Jersey, New Hampshire and Connecticut among the states leading the nation in the amount of student loan debt per resident, ranging from $32,247 to $38,510 on average. Use your tax refund to make couple of payments and get that much closer to being debt-free.

Refinance Mortgage

If finances allow, you can save your tax refund to refinance and reduce the amount of interest owed on your mortgage loan. Just be sure that the amount you’ll save by refinancing exceeds what you would need to pay in closing costs.

Create an Emergency/Rainy Day Fund

According to a recent Bankrates survey, less than 40 percent of Americans would use their savings to deal with emergencies such as a hospital stay or unexpected car repair. More than a third of those surveyed mentioned that they would need to borrow the money, either through a loan, a credit card or family members and friends. The recommended amount to have saved for an emergency is anywhere from three to none months’ worth of wages.

If you don’t need to pay off any immediate debt and your emergency/rainy day fund needs a little padding or you need to create one, use your tax refund to give it a boost. Whether you want to create a separate account for this emergency fund, stash it in your savings or want to store the money some other way, the choice is yours.

Build up Savings Accounts

If you feel that you have your debt and emergency/rainy day fund taken care of, you can also use your tax refund to bolster your savings. Plus, as a AAA member, you have the option to open a savings account. There are several types of savings accounts in which you can invest and put your tax refund in.

Traditional Savings – This type of online savings account is the most common. If you need to withdraw money quickly it is also the easiest as there are no penalties for early access.

Money Market Account – A high yielding savings account that also gives you the ability to access you funds by writing a check or using a debit card.

Certificate of Deposit – Because you can’t touch it until its maturity date, a CD is a smart way to meet financial goals over time. Use your tax refund as a starting point and watch it grow. CD terms are available from three to ten years.

Contribute to Your Retirement Fund

There are several ways you can contribute to your retirement with your tax refund.

Invest in an IRA

Individual retirement arrangements (IRAs) are ideal for those who don’t have huge credit card debt, already have a set emergency fund and are looking to grow their savings. And IRAs do, in fact, pay off. As you add more it will grow more, but if you withdraw from this fund before you’re 59 1/2 years old, generally you will have to pay a 10 percent penalty (although there are exceptions, per the IRS).

Invest in a Roth IRA

You can also use your tax refund and invest in a Roth IRA. The difference between a Roth IRA and a regular IRA is that a Roth IRA has no up-front tax deduction. The distributions are tax-free and you can access this IRA at any time with no penalty. This IRA makes more sense to use if you expect the tax rate to be higher when you retire than currently.

How do you plan on using your tax refund? Saving or spending? Tell us in the comments.

Learn more about the ways AAA can help you handle your savings.