- If you got an unexpected tax refund this year, it can be tempting to spend it all.
- But if you invest it strategically, you can build wealth and earn passive income for years to come.
- Put it in a high-yield savings account or IRA, or put it towards a rental property purchase.
- Read more stories from Personal Finance Insider.
If you received an unexpected tax refund this year, don’t go spending it just yet. While it can be tempting to view the refund as “extra money,” there are ways you can use it to build wealth. And while you may want to treat yourself to a big purchase or travel adventure, putting your refund towards your short- and long-term financial goals is an even better idea.
Here are a few ways you can use a tax refund to build wealth throughout 2021.
1. Pay down debt
2020 was a hard year financially for many. If you racked up some credit card debt in 2020, put your tax refund towards your debt. Nothing slows down wealth-building like high-interest credit card debt.
If you have multiple balances, you can use the debt avalanche method (where you attack the highest-interest debt first) or the debt snowball method (where you attack the highest balance first) to pay them off. Otherwise, put your whole refund towards your credit card bill.
2. Build an emergency fund
If you don’t already have an emergency fund in place, now is the time to build one. An emergency fund is typically three to six month’s worth of expenses saved, but can exceed a year or more.
If your refund was large enough to get started but not enough to fulfill this amount, don’t worry. Now that you’ve got a base of funds, set up automatic monthly transfers to your savings account to hit your goal. A high-yield savings account can help you earn interest on your emergency fund while the money’s not in use.
3. Set up sinking funds
Emergency funds oftentimes get misused for expenses we failed to plan for but certainly don’t classify as emergencies. For example, if you pay your auto and home insurance premiums every six months, the bill may blindside you if you aren’t expecting it. Same goes for a vacation. If you’re not saving for it specifically, it can be hard to pay for it up front or pay off a credit card used for the trip.
The solution? Sinking funds. Sinking funds are separate savings accounts set up for upcoming expenses, such as travel, home repairs, schooling, kids’ needs, etc. In order to set up sinking funds, first take a look at your previous spending and determine where the blind spots were. From there, you can open separate savings accounts and then have money automatically transferred into them for each expense. If you choose a high-yield savings account, your money can earn interest while it sits in your account.
4. Start an investment account
An unexpected tax refund can be a great way to jumpstart your investing journey if you haven’t started yet. There are many brokerages that require a minimum amount to open a Roth IRA, but some that do not. Fidelity, Charles Schwab, and TDAmeritrade are a few examples of brokerages that do not require a minimum balance to start investing.
While you don’t have to invest your entire tax refund off the bat, even allocating a chunk to investments will help you reach your long-term goals sooner.
5. Beef up existing investment accounts
If you have opened an IRA in the past but have yet to max it out each year, this could be your chance. The maximum contribution for 2021 is $6,000 per person ($7,000 if you’re 50 or older) If you have an account open but don’t have regular contributions set up, or do but they don’t max out your account, consider contributing at least a portion of your tax refund.
6. Invest in yourself or your career
According to Kimberly Hamilton, founder of Beworth Finance, investing in your career is also a smart move. “Investing in your career can be one of the most rewarding and fruitful uses for your tax refund. Take time to identify courses or workshops that might help you gain the skills necessary to take your career to the next level, and use your refund to start the process.”
If you’re an entrepreneur, consider taking a course or attending a conference that will help you learn new skills or network with others in your field. While it may seem fruitless at first to invest in yourself, the payoff can yield greater returns in the long run.
7. Save for an investment property
If you’re interested in passive-income opportunities during retirement (or before!) an investment property may be a good idea. Although the housing market is hot and it may be harder to find a deal right now, there are people out there purchasing their first, second, or third rental properties. Although not for everyone, purchasing a property to flip or rent can be a way to build wealth for the future. And while it’s unlikely your tax refund will cover the entire down payment on a property, you can sock it away until you are ready to buy.
Regardless of whether you decide to save or spend your tax refund, be sure to consider your options and weigh the pros and cons before you choose. While it may initially feel great to spend your hard-earned money, putting your refund towards a future financial goal will help you build wealth in 2021 and beyond.