Smart Strategies: What to Do With My Tax Refund?

According to the IRS, 64% of Americans received a tax refund in 2023, with an average amount of $2,800.¹ And when asked what they plan to do with the money, "save it” was answered most.²

If you’re asking yourself, “what should I do with my tax refund?” financial consultants Trey Byrd and Duo Tran offer specific tips to make the most of your payback from Uncle Sam.

What Should the Priority Be for My Tax Refund? Debt

Our consultants say improving your financial situation should take priority if you’re getting a refund. And if you have high-interest debt, start there.

“Paying down debt would be where I’d want people to focus first,” says Trey. If you’re spending more on a loan or credit card interest than you’re receiving from your investments, you’d want to tackle the debt. And there are a couple of ways to do that—starting with your tax refund.

Using your tax refund to pay down the debt with the highest interest rate would be considered the “avalanche” method. And while Trey says this method makes sense mathematically, some people prefer—and are successful—using a “snowball” approach because of its psychological benefit.

The snowball approach is paying off the smallest debt first, regardless of interest rate. This method seems to make people feel better because they can see progress from paying off a smaller bill and it keeps them motivated.

What’s Next for My Tax Refund? Your Emergency Fund

Duo and Trey agree that a good next step for your tax refund may be to bolster your emergency fund. Keeping your money in a cash equivalent investment, such as a money market fund, or in high-yield savings, may be something clients want to consider, especially now.

Trey says, “Many financial pundits believe stocks are currently overvalued, so as far as investments go, investors should be more careful about purchases when prices are high. And especially if prices are too high.

“It may be smart to build your cash reserves now,” agrees Duo. “Especially if you need more in your emergency fund. The last thing investors may want to do is to lock it up in other kinds of accounts, such as an IRA, which could mean penalties if you need to withdraw the money before age 59½.”

Another reason for cash reserves? Dry powder, which is cash or securities you can convert to cash, that has a two-fold purpose. “In addition to having lower-risk accounts that give you easier access to the money for an emergency, dry powder can be for investing in opportunities that spring up—such as if equities experience a downturn and you can purchase them at a lower cost,” says Duo.

What Else Can I Do With My Tax Refund? Invest in the Future

If you’re in a good place with debt and your emergency fund is well-funded, the next step may be to look to the future with your tax refund. That could mean investing for someone else or yourself.

Consider College Savings

If you have kids or grandkids, a smart way to fund their education is with a 529 education savings account. And the so-called “grandparent loophole” which takes effect the 2024-25 school year may mean good news for grandchildren.

“Starting the next school year, 529 accounts owned by a grandparent will no longer count against a student’s eligibility for financial aid on the Free Application for Federal Student Aid, or FAFSA,” says Duo. Under previous rules, a grandparent 529 distribution could be counted as the student’s income and impact whether they received aid, or how much.⁴

529s offer more than the ability to save for a student’s education. There are also other benefits  you may want to check out before investing a tax refund or other sum of money.

Help a Child With a Down Payment

Wanting to help your family with your tax refund? One avenue may be gifting them a down payment for their own home. As home prices continue to rise, more and more parents are helping their children with a down payment. According to one survey, 39% of homeowners have received down payment assistance, mostly from their parents.⁵

“If you’re planning to help out a family member with a down payment gift, there are rules you need to know about,” says Trey. So be sure you understand how much you can give without impacting your own financial situation.

Consider Your Retirement

While our consultants said debt or an emergency fund were their first choices for a tax refund, investing in your future can also be a good choice.

“It never hurts to grow your nest egg with a lump sum investment,” says Duo. They’d never frown at someone trying to save more for the future. But it also doesn’t have to be in an IRA. You could consider a taxable account too.

Trey says people may want to think about which year they will contribute to for an IRA. You can contribute for last year’s IRA until the tax filing deadline—in this case April 15, 2024. If you’re receiving your refund and want to contribute for last year, you will have to refile.

Should I Rethink Receiving a Tax Refund? Maybe

Both consultants believe that while getting a tax refund can feel great when the money comes through, you may also want to consider why you overpaid and what your alternatives might be.

Duo says some people may be trading their own investment opportunity with a lump sum reimbursement from the IRS. “If people are earmarking a tax refund for a vacation or to pay off debt, there may be a better way, such as considering a high-yield savings account that will pay you interest.”

Trey agrees. "A tax refund is because you paid too much in taxes. The IRS will not pay you interest on money you overpaid and that it's been holding.

If you reduce your tax withholding, you could use that money to make your own potential interest or returns. Then you can pay down debt or build up your emergency fund with the money plus potential earnings on it. Of course, many people don’t want to “owe” the IRS at the end of the year—they’d rather overpay.