It’s Tax Refund Time: How Will You Spend Your Windfall?

Tax season can be a grueling time of year, but if you’re like most people, the big payoff you may get in the form of a refund makes it all worth it.

The IRS estimates that the average refund for 2013 will be $2,803, and if you’re dreaming of putting that money towards a Caribbean vacation or a new designer wardrobe, you’re not alone. A recent study from Capital One Bank found that 23 percent of people plan to spend their refund on a vacation, while another 16 percent will put it toward clothing and accessories. But before you start shopping for a travel agent, it’s important to think about other ways of spending your refund that can contribute to your long-term financial health. Examine the areas below to determine if your refund would be better spent elsewhere.

1. Debt:
If you’re carrying credit card or loan balances, putting several hundred dollars or more toward your debt is never a bad idea. Not only will you help cut down your principal balance, but also reduce those high interest charges you’re paying. This can free up more income to put toward eliminating your remainder, putting money into savings or accomplishing a financial goal.

2. Emergency savings:
If you find it difficult to save money for emergencies, your refund can help you get started. A cash cushion can help you out of a tight spot, and protect your regular savings should you befall a financial emergency. It can also protect your credit health by lowering your risk of being forced to turn to credit if you don’t have the cash to cover an unexpected cost.

3. Retirement:
When it comes down to using your refund to open an IRA versus taking a trip to Italy, the former option may feel a little painful (or maybe you can do both!) but deep down, you know that planning ahead for your golden years will allow you to live the lifestyle you want to lead after you stop working and if you make a good decision today, maybe next year a great trip will be in order. Keep in mind that you don’t have to contribute the whole of your refund toward this goal – but a little bit can go a long way as the years pass and interest accrues.

Using your refund to pay off bills or save for an unexpected emergency may not seem particularly exciting, but take comfort in the long-term benefits of making these decisions. Making smart financial decisions now will enable you to work toward financial freedom in the future.