Tax season began on January 23, and millions of Americans are eagerly expecting a tax refund. They might be in for a tidy sum: the IRS says that the average tax refund in February 2023 is $1,997, which is down from $2,323 in 2022. Some taxpayers will use their refund on essentials – to pay their bills, to pay down debt or simply to sock away money for an emergency. Others might think about investing it in their future. Let’s take a look at a few smart things you can do with your tax refund in 2023.
A financial advisor can help you invest your tax refund or put it toward your financial plan.
Immediate Needs: Bills and Debt
First things first: If you’ve got bills and other pressing financial needs, these are the priority. Dealing with pressing financial matters, like paying for rent, utilities and other necessary bills, should always be a priority. This is key to remaining financially stable, and an effective strategy to safeguard against debt.
Next, if you’ve got a significant amount of debt – particularly high-interest debt – then you should use your tax refund to pay down this debt. Credit card debt, which typically has high interest rates, will likely be top priority. Paying off other types of debts, like student loans and mortgages, may or may not be a priority depending on the interest rate you’re paying on that debt.
If your emergency fund has been depleted during this economically challenging time, you should use your tax refund to rebuild it. This could help protect you against unexpected emergencies like the sudden loss of employment or additional health expenses.
Boost Your Retirement Plan
If you don’t have any pressing needs or high-interest debt, then putting your tax refund toward retirement is a great move for your long-term finances. Years of investing returns in a tax-advantaged retirement account can turn a modest tax refund into a significant amount of retirement income.
A Roth IRA, for instance, is a popular retirement plan for young investors who are starting out in their careers. While you pay taxes when you put money into this individual retirement account, withdrawals made over age 59 1/2 are tax-free. Note that in 2023, you can contribute up to $6,500 to a Roth IRA (which is up from $6,000 in 2022) and $7,500 if you are age 50 or older (up from $7,000 in 2022).
By comparison, you can also invest your tax refund in a traditional IRA. Unlike a Roth IRA, you will be taxed after retirement when you take money out, but you get to take a deduction on your taxes for any money you put in.
Both traditional IRAs and Roth IRAs have the same contribution limits in 2023. Keep in mind, however, that you will have to make required minimum distributions (RMDs) for your traditional IRA if you turned age 72 in 2022 and 73 in 2023.
If you are a taxpayer with a 401(k) plan, then using your tax refund to boost your pre-tax contributions is another smart way to maximize your retirement savings. While 401(k) contributions are deducted from your paycheck, what you pay now will compensate you more in retirement. Especially if your boss matches those contributions, which essentially means that you are getting free money for every payment that you make into your retirement plan.
SmartAsset’s retirement calculator can help you figure out how much money you will have when you retire.
Invest in Stocks
Whether you put your refund in a retirement account or a regular brokerage account, investing it in the stock market will pay off in the long run. While stocks can be more volatile in short intervals than other types of securities, experts say that it delivers higher returns on long-term investments. That is why many first-time investors work with financial advisors to create a plan for their investing goals.
Stocks are equities or shares of a company that you ideally want to buy at an affordable price and hold on to them over time so you can sell them for a higher profit. If you have a 401(k) plan, then you are most likely already invested in stock through your employer. You can buy individual stocks or bundles of stocks (either in the form of mutual funds or exchange-traded funds) through traditional investment brokers, online brokers and do-it-yourself robo-advisors.
Your success will largely depend on your time horizon, which is how long you intend to hold onto an investment and how much risk you are willing to take on to grow your money. If you’d like to invest but aren’t comfortable with the risk in the stock market, consider bonds, either corporate or government, or bond funds. Also known as fixed-income securities, these are essentially debt instruments that are publicly traded. If you’re not sure how to invest in fixed-income securities, consider a bond index fund.
SmartAsset’s investment calculator can help you figure out how much your money could grow over time.
Seed a 529 College Savings Plan
If you want to lessen the financial burden of higher education, then investing some or all of your tax refund in a 529 savings plan is a smart way to pay for the rising costs of college and safeguard against mounting student debt.
Taxpayers can get state income deductions or credit for their 529 contributions. And withdrawals aren’t taxed as long as they are used for qualifying expenses like paying for college tuition, books and school supplies, and on-campus room and board.
If you are a parent, then you might want to consider investing in a 529 plan for your child. However, you can also benefit from this plan if you intend to go back to school as an adult or further your education through a graduate program.
There are many types of plans and diverse investment portfolios to help fund your education goals. The U.S. Securities and Exchange Commission says that all 50 states and the District of Columbia offer at least one type of 529 plan.
In order to maximize the use of your 529 plan, and the tax refund money that you are investing in it, you will need to project the annual tuition of the college, additional monthly contributions, and other variables that will impact how much you have to save.
SmartAsset’s 529 college savings guide breaks down plans by state and will help you calculate some of these variables for your plan.
Invest in Your Health Savings Account
Investing your tax refund in a health savings account (HSA) is a smart choice if you want to set tax-free money aside to pay for future medical expenses. And, if you don’t end up needing the money, you can also use your HSA to save during retirement.
You should keep in mind that taxpayers can only qualify for an HSA if they are enrolled in a high deductible health plan (HDHP). The IRS defines an HDHP in 2023 as a health insurance plan with a minimum annual deductible of $1,500 for individuals (up from $1,400 in 2022) and $3,000 for families ($2,800 in 2022). It has a maximum out-of-pocket cost of $7,500 for individuals ($7,050 in 2022) and $15,000 for families (up from $14,100 in 2022).
The money that goes into your HSA is tax-free, which means that your contributions will not be taxed. And you can also take out that money tax-free as long as it’s used for qualifying medical expenses. Furthermore, your gross income is lowered when you put money into your HSA. So if you earned $42,000 in tax year 2022, and you put $1,500 into your account, then your gross income will be $40,500 when your taxes are filed in 2023. In this case, your tax rate would drop from 22% to 12% by moving into a lower income bracket.
Note that HSA contribution limits for 2023 are $3,850 (up from $3,650 in 2022) for individuals and $7,750 ($7,300 in 2022) for families. And your contribution limit increases by $1,000 when you are age 55 or older.
Another advantage of funding an HSA is that you can use it as an additional source of income during retirement. When you take out HSA funds to pay for expenses outside of healthcare, you get taxed for that withdrawal and the IRS imposes an additional 20% penalty. But, if you are age 65 or older, that penalty gets waived and you are taxed at the regular rate.
Work With a Financial Advisor
A financial advisor can help you invest your tax refund. Financial management often requires big-picture insight, and an advisor could use that expertise to address your financial needs specifically.
Before you spend your tax refund, an advisor will help you create a financial plan to map out the areas where you can benefit most.
These could include maximizing your retirement income for Social Security, managing investments to identify new opportunities, planning your estate to take care of family, or optimizing a tax strategy for your finances, among other important decisions.
Whether you are starting out on your career, or just a few years away from retirement, the good decisions that you make today will pay off at a greater scale in the future. And a financial advisor is a smart choice to help turn your tax refund into an important step for your goals.
A tax refund can be a much anticipated boost for your finances. But if you don’t need the money for anything urgent, you can invest it in a smart way for your future. Whether you plan on saving for retirement, make your money grow in the stock market, finance your education or save for health expenses, working with a financial expert can help you set and reach these financial goals.
Tax Planning Tips
- If you would like to work with a financial advisor to invest your tax refund or put it toward your financial plan, SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- A financial advisor who specializes in tax planning can also help you lower your tax bill by harvesting your tax losses. This means that you will be able to use your investment losses to reduce taxes on capital gains or income.
- SmartAsset’s tax return calculator can help you plan ahead for the tax season by figuring out your tax refund or tax bill.
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