The average tax refund last year was $2,869, according to Bankrate. While average tax returns vary greatly from state to state, it’s not exactly a bad thing if you’re getting much less than $3k back from the IRS. In fact, your ideal tax return should amount to as close to $0 as possible.
The Case for a Smaller Tax Refund
While getting a chunk of change from the government each spring can feel like a nice bonus, it actually means you’re letting the IRS borrow your hard-earned income without paying interest on it all year.
Eye opening, right?
Here’s what you can do about it:
- Adjust the amount you’re withholding on your IRS Form W-4.
- Make the best investments right now to get the most out of your tax return.
The Best Investments for Your Tax Return
- Build an emergency fund
Some financial advisors argue that paying off high-interest debt should be the top priority when you come into unexpected cash. At Paradigm Life, we recommend having at least six months of savings before considering other investments.
If you don’t have any funds to fall back on if you lose a job, become disabled, or run into an unexpected home or medical expense, you’ll end up having to go back into debt to pay your unexpected bills. This makes it even harder to achieve financial independence.
2. Pay off high-interest debt
Once you’ve established an emergency fund, the next best investment is paying down debt—but not all debt. Specifically, pay down your high-interest debt. Some debt, like your mortgage, typically has a lower interest rate than the interest your money could earn in another account. The idea is to always have your money making more interest than you pay.
3. Consider alternative ways to save
Savings accounts are safe places to keep your money, but they offer minimal growth. When you consider inflation, money sitting stagnant in a savings account is becoming less valuable year after year. Money market accounts and CDs offer slightly better rates, but aren’t always robust enough to outpace inflation. A third alternative is a dividend-paying whole life insurance policy. It offers improved returns without the risk of stock market fluctuations.
4. Invest in yourself
If you own a business or are considering going back to school, both of these are valid investments for your tax refund. Ultimately, these types of investments produce passive cash flow and increase your earning potential. For more information, check out Measuring Human Life Value with The Human Capital Statement.
5. Invest in your family
If you have kids, taking out life insurance policies on them offers a variety of benefits: funding college tuition, teaching them about money, and setting them up for financial success, to name a few. Policy premiums can be as little as $50/month. You may also be able to take out life insurance policies on your spouse or parents, increasing the power of the family bank.
6. Invest in real estate
Whether you’re putting money into property you already own to increase its value, purchasing additional property, or contributing to a REIT, real estate can be a profitable investment. Be sure you have a solid financial foundation before you embark on property investment. At Paradigm Life we use The Hierarchy of Wealth to outline best-practices for wealth strategy.
7. Fund your retirement account
Assuming you have a healthy emergency savings and financial foundation in place, it may be time to look at your IRA and see if it’s underfunded. You can have the IRS deposit your tax return directly in your IRA. (Unfortunately, if you have an employer 401(k), this isn’t an option.) Alternative options include funding other types of retirement accounts, like your Wealth Maximization Account™, for even better tax advantages.