What Do I Do With My Tax Refund?

How much more peace would you have if you used that money to pay off debt or beef up your savings instead? Maybe then you could get a good night’s sleep without worrying about how you’re going to keep the lights on.

The point is, your tax refund (which is simply the government returning money that should have been in your pocket all along) could help you make some real progress on your money goals . . . if you don’t spend it all in one place.  

What to Do With Your Tax Refund

So, if you do wind up with a hefty tax refund this year, what should you do with your refund? It honestly depends on where you are on your financial journey.

Using Dave Ramsey’s 7 Baby Steps as a framework, you can decide where to put those tax refund dollars to work. Depending on which Baby Step you’re on, the goal here is to make the most progress toward your most pressing money goals. Here are a few ideas to help you get started!

How Do I Use My Tax Refund Based on the Baby Steps?

Baby Step	Your Situation	Best Use of Tax Refund
Baby Step 1	Your starter emergency fund ($1,000) isn’t complete.	Start by building a starter emergency fund of $1,000.
Baby Step 2	You’re still paying off all nonmortgage debt.	Put your entire refund toward debt using the debt snowball method.
Baby Step 3	You’re debt-free (except the house), building 3–6 months of emergency expenses.	Use your refund to boost your emergency savings.
Baby Step 4	You’re debt-free with emergency savings and investing 15% for retirement.	Invest your refund in good growth stock mutual funds or save for large purchases.
Baby Step 5	You’re saving for your kids’ college expenses.	Make an extra contribution to a 529 plan or ESA.
Baby Step 6	You want to pay off your home early.	Make an extra mortgage payment toward the principal.
Baby Step 7	You’re completely debt-free, building wealth and giving generously.	Use your refund to invest, give or save for large purchases.

1. Pay Off Debt Faster With Your Tax Refund

If you’re on Baby Step 2, this is exactly where you should start! About 20% of folks plan to use part of their tax refund to pay off at least some of their debts, according to a recent survey.² 

As long as you have $1,000 in a starter emergency fund, you should use your tax refund to pay down your debt. We ran some numbers to find out what would happen if you got gazelle-intense and used your entire refund to pay down your debt. You might be surprised by how much you could actually save in interest and payments with this one simple step.

Student Loans

The average student loan balance is around $37,000.^3,4 So, let’s say your balance is $37,000 at a 6% interest rate on a 10-year loan. With a monthly payment of $410, you’ll shell out about $49,300 in principal and interest over the life of the loan.

But let’s say you put your $3,400 tax refund toward your student loan balance. If you did that, you’ll pay off your loan a year earlier and save more than $2,500 in interest.

Now let’s take things a step further. Getting a $3,400 tax refund doesn’t mean you hit the jackpot. It’s simply the government returning your money that you’ve been overpaying them—money you could have been using all year long to pay extra on your debt. Your goal should be to have a tax refund as close to zero as possible so you’ll have more money in your paycheck.

Don’t wait until next year to get your money back. Work with a tax advisor or your payroll department to adjust your withholding today so you can bring home an extra $283 a month ($3,400/12), starting with your next paycheck!

Then you can use that money to pay a little extra each month on the remaining balance of your student loan debt. With this method, you’ll pay your loan off in a little over five years instead of 10. And you’ll save an additional $6,000 in interest!

That’s how you put a tax refund to work! Here’s how that same scenario can work on your other debts:

Credit Cards

Did you know the average American family is carrying around $6,120 in credit card debt?⁵ Yikes! If you only pay the minimum payment of 2.5% of the balance each month, along with a 25% interest rate, it’ll take you more than seven years to pay that off. But if you chuck that $3,400 tax refund at the balance when you get your refund, you’ll knock that sucker out in two years and save yourself a bunch of money in interest!

Seeing how much progress you can make with your tax refund will light a fire under you and motivate you to pay off your debts even faster. And adjusting your tax withholding will only add more fuel to that fire.

Car Loans

The latest research shows that the average used car loan is more than $27,500 at an 11.2% interest rate.⁶ Most people finance their cars for five years, although the average term is creeping toward six. With your one-time $3,400 payment followed by your increased monthly payments of $283, you’ll pay off your wheels almost three years sooner and save more than $5,100 in interest!

2. Use Your Tax Refund to Save for Emergencies

According to The State of Personal Finance, less than half of Americans (45%) are “very confident” they could handle a $1,000 emergency expense. That’s a huge problem, and it’s probably why many Americans plan to put part of their tax refunds into savings last year. 

Here’s the deal: You need to have 3–6 months of expenses saved up in an emergency fund (or have a starter emergency fund of $1,000 if you’re still paying off debt) to help protect you financially from anything life throws your way. If you don’t have that full emergency fund yet, that means you’re on Baby Step 3 and this is where your tax refund can do the most good.

If you don’t have enough money in the bank to cover a tire replacement or a trip to the emergency room, your tax refund can give your emergency savings a much-needed boost. And that’s a way more responsible option than spending it all on a late-night online shopping spree. (Resist those impulse purchases!)

3. Invest More for Retirement With Your Tax Refund

Now this is where you can really start using your tax refund to build wealth. If you’re out of debt and have a fully funded emergency fund, you’re on Baby Step 4 and ready to invest! Check out our Investment Calculator to see how your tax refund can do great things for your retirement account.

With an initial investment of your $3,400 tax refund followed by monthly contributions of the $283 you gained after adjusting your withholding, you could add roughly $884,000 to your nest egg over 30 years! That’s just $101,880 of contributions, but more than $779,200 of growth. This is one simple way to catch up if you’re feeling behind on your retirement savings goals.

4. Give Your Kids’ College Fund a Boost

In case you haven’t noticed, getting a college education isn’t getting any cheaper. According to some of the latest estimates, the average cost of tuition for a four-year in-state school is $9,750 per year . . . and that’s not even counting the cost of books, supplies and other daily expenses!⁷

If you have plans to send your little ones off to get a degree—whether it’s at a local university, a trade school or some other institution of higher learning—your tax refund could help get them there!

If you put a $3,400 refund into your child’s 529 plan or Education Savings Account (ESA), invest it in good growth stock mutual funds, and let it grow for 18 years, they could have more than $24,000 saved up in their account by the time they receive their high school diploma. And that’s assuming you don’t invest another dime!

5. Pay Off Your Mortgage Faster With Your Tax Refund

If you have a mortgage, chances are it’s the largest debt balance you have—which makes sense because a home purchase is usually the largest purchase you’ll ever make. In fact, the average mortgage balance is now more than $260,000.⁸

Along with that mortgage amount, let’s assume you have a 15-year mortgage with a 5.5% interest rate. Using our Mortgage Payoff Calculator, you can see that with your tax refund and increased monthly payment of $283 (from your newly adjusted withholding), you’ll pay off your home nearly three years early and save around $26,000 in interest. The grass in your backyard is about to feel a whole lot greener!

6. Use Your Refund to Save Up for a Large Purchase

You might be looking out the window at your old, beat-up car in the driveway and thinking it’s time for an upgrade before the wheels start falling off. Or maybe you and your spouse are in desperate need of a getaway, and using your refund to pay for a cruise to the Caribbean is really tempting!

But before you start buying cars, couches, or taking vacations, you need to be debt-free (everything except for your home) and have a fully funded emergency fund. No exceptions! As long as you’ve completed Baby Step 3, there’s nothing wrong with setting aside at least a portion of your refund to save up for a large purchase.

 

If you’re married, just make sure that you and your spouse are on the same page about how to spend your tax refund. And if you’re single and struggling to figure out how to best spend your tax refund, find someone you trust—maybe a good friend or a wise family member—and bounce your ideas off them.

Don’t Forget to Adjust Your Tax Withholding

Remember that a tax refund is not a bonus—it’s your money that you’ve been loaning to the government all year long without interest. It’s money that should have been in your pocket this whole time. Don’t make that mistake again this year!

An experienced tax professional can help you get your taxes done and work with you to adjust your tax withholding so you aren’t giving the government more than they’re owed from each paycheck.