Receiving a tax refund can feel like a financial windfall, providing an unearmarked sum of cash that presents a unique opportunity to strengthen your financial standing. However, with life’s ongoing demands and unexpected expenses it is easy for good intentions to get bypassed and be left with a feeling of treading water. Below are a few ideas on leveraging your tax refund to maximize its impact in line with your overall financial goals.
Accelerate Debt Repayment. Put your tax refund to work by speeding up the repayment of outstanding debts. Whether it is paying down student loans, auto loans or a home equity line of credit, you can significantly reduce the total interest paid and expedite your path to debt-free living. Often the debt with the highest interest rate is where to begin. Talking with your financial planner will provide insight into what works best for your specific situation.
Bolster Your Cash Reserve / Emergency Fund. Ensure greater financial stability by increasing your cash reserves. An emergency fund acts as a safety net for unforeseen expenses like home or auto repairs, or in the event of a job loss. If your emergency fund is not ready to cover three to six months of regular expenses, consider using your tax refund to solidify this vital financial safety net.
Supercharge Retirement Savings. Boost your retirement nest egg if you are not already maximizing your contributions. Pretax contributions to your employer 401k or an IRA will reduce your taxable income for the current year. A Roth IRA might make even more sense if eligible since from an emotional standpoint this is money that is not coming from your regular paycheck so getting into the potential “tax-free” world of the Roth doesn’t impact your on-going spending.
Diversify Your Investment Accounts: If you are already maxing out your retirement contributions, explore opportunities beyond retirement accounts such as an after-tax brokerage account invested in a manner aligned with your financial goals.
Accelerate Savings For a Major Financial Goal: Maybe it is saving for a down payment on an house, or a special vacation, your tax refund can accelerate your savings progress to that goal. Choose an appropriate savings vehicle based on your time horizon for the goal and accessibility needs. Right now, high yield savings accounts or certificates of deposit are a good choice for many intermediate goals.
Take Advantage of a Health Savings Account If Eligible. If you have a high deductible health plan you should explore maxing the contributions to a Health Savings Account. An HSA potentially has a triple tax benefit. Contributions are deductible at the federal level, growth is tax-deferred, and distributions are potentially tax free if you follow the rules. (Look for more in-depth information about HSAs in a blog post in May).
Invest in Education: Invest in your child’s future by using your tax refund to jump start or increase 529 savings. 529 plans provide tax-free distributions for qualified education expenses and now thanks to the Secure Act 2.0 some funds from an established 529 account can be transferred tax-free to a Roth IRA for the beneficiary of the 529 account. Do note that there are limitations and many nuances to navigate so working with your financial planner is highly recommended.
Using your tax refund to strengthen your financial plan is great. However, if you are getting a refund that means you have made an interest free loan to the government. Adjusting your tax withholding for the current year to prevent overpaying taxes will likely free up take home pay throughout the year, allowing you to allocate more to your financial goals on an ongoing basis.
Every financial decision should be made in alignment with your long-term objectives and risk profile. Lake Tahoe Wealth Management is here to provide support and guidance. Reach out with questions on how to best leverage your tax refund to improve your personal financial plan.