For most Americans, a tax refund can offer a lifeline for their finances—especially considering recent inflation, increased interest rates, and economic uncertainty. It can be a welcome relief for many, allowing for important financial goals to be met, such as debt consolidation or increased savings.
With the average tax refund for 2023 clocking in at $2,933, there are plenty of opportunities to use the lump sum to boost your finances; however, the most important component is having a solid plan to ensure you’re getting the most bang for your buck.
In this article, we will delve into the strategies for optimizing your tax withholding to maximize your financial gains. Additionally, we will discuss the diverse array of options at your disposal to effectively utilize your tax refund and make progress towards achieving your goals.
How to Calculate Your Tax Withholding
Several factors go into calculating your tax withholdings such as your filing status, total income, deductions, taxable income, and qualifying tax credits.
Your filing status can affect whether or not you need to file a federal tax return, your standard deduction, and access to certain credits. The filing status options are single, married filing jointly, married filing separately, head of household, and qualifying widow or widower with a dependent child.
Your total income includes all of your (and your spouse’s, if applicable) total gross income from the year from a W2 position, self-employment income, dividends, tips, interest, etc.
Deductions decrease your tax burden by reducing your total income. There are standard deductions ($12,950 for single or married filing separately, $25,900 for married filing jointly or surviving spouses, and $19,400 for head of household).
Alternatively, you can choose to itemize deductions if it suits you better financially. If you chose this option, you’ll need records of your deductible expenses such as mortgage interest payments and charitable contributions.
Your taxable income (total income minus deductions) is what determines your federal tax bracket and is the income that is used as a basis for what you will owe taxes on.
Tax credits will also factor into your tax withholdings and potential return amount. Popular tax credits include the Earned Income Tax Credit for low-to-moderate income households, the Child Tax Credit for dependent children under age 17, and the American Opportunity and Lifetime Learning tax credits for eligible students (and their families).
Ways to Maximize Your 2023 Tax Refund
After determining and implementing your tax withholding strategy, you may be entitled to a refund due to overpayment throughout the year. Regardless of how much money you receive, there are plenty ways to use it to your financial advantage. Top options below represent ideal ways to invest your refund; however, each is dependent on your personal situation, goals, and desires.
1. Decrease your debt
Paying off debt can certainly feel like a slow and monotonous process. Allocating a large sum of money into debt, however, can feel empowering and motivating, and help boost your financial roadmap.
Focus on your high-interest debt first. For instance, you could choose to begin with any debt that holds an interest rate over 6%. Consider any credit card debt, auto loans, and personal loans first and foremost.
If you don’t have any high-interest debt, consider making an extra mortgage payment. A couple of extra payments toward your principal may not seem like it would be impactful, but extra payments can really add up in the long run and decrease the overall interest you pay substantially.
Overall, paying off debt and decreasing your liabilities can help advance your financial situation, increase your monthly cash flow, and improve your credit score.
2. Stack your savings
If you don’t already have an emergency fund, starting one with your tax refund is a great savings option. Aim to have at least three to six months of expenses saved in case of an unexpected financial emergency.
We recommend increasing your fund amount if you work in a volatile job market, have dependents, and/or have higher healthcare expenses. Alternatively, you may not need to fund quite as much if you have a stable career, no dependents, and/or a low amount of debt.
Another option for your tax refund is creating sinking funds. A sinking fund is a predetermined amount of money that gets set aside for an upcoming expense – and it fall outside of your monthly expenditures.
Sinking fund examples include a down payment on a house or car, a vacation, car maintenance, veterinary bills, etc. It can even be for things like your car insurance if you pay it in 6-month installments. Sinking funds are an excellent way to cash flow expenses without disrupting your monthly budget.
You can hold your emergency fund and sinking funds in high-yield savings accounts. Lafayette Federal Credit Union offers Preferred and Premier Savings Accounts, both of which offer increased rates with higher balances.
Certificates are another great place to hold sinking funds. They typically offer higher interest rates than savings accounts, but the money must remain untouched for a pre-determined length of time.
Lafayette Federal Credit Union offers nation-leading fixed-rate certificates ($500 minimum deposit), fixed-rate jumbo certificates ($100,000 minimum deposit), and variable-rate certificates ($50 minimum deposit). As of May 1, 2023, the rates are offered as high as 5.15% APY (depending on the type of certificate and term).
3. Invest your funds
Investing is another fantastic way to put your tax refund to work. You can invest in an investment account, in yourself, or even in valuables such as your home or car.
Consider depositing your refund into an individual retirement account (IRA). This year, 2023, the contribution limits for an IRA are $6,500 for those under age 50 and $7,500 for those age 50 or older. Contributing to a retirement account will allow you to maximize your tax refund because it has the potential to grow and serve your future self.
Another consideration is contributing to a Health Savings Account (HSA) if you have access to one. The HSA contribution limits for 2023 are $3,850 and $7,750 for individual and family coverage, respectively. These accounts can be used to pay for qualified medical expenses such as copayments, deductibles, and pharmaceuticals.
HSAs have a triple tax-advantage – your contributions are pre-taxed, your funds grow tax-free, and your withdrawals are tax-free. These accounts help pay for medical expenses and can also be a part of a robust retirement plan.
Another account to consider is a 529 Plan. If you have children, these accounts are a flexible, tax-advantaged way to save for their education. 529 plans do not have contribution limits themselves, but any amount over $17,000 can be subject to gift tax, check with your state for full restrictions!
Lafayette Federal Credit Union offers a Coverdell Educations Savings account where our members can contribute up to $2,000 per tax year. The earnings in the account are also free! So when it’s time to withdraw to pay for school expenses, you won’t have to worry about extra fees.
Another investment option is to invest in yourself! Taking care of your body, mind, and spirit can help you enjoy life, be more productive, and can ultimately positively impact your finances.
Invest in your physical health by buying a piece of home workout equipment that you know you’ll use, or sign up for a new fitness class that intrigues you. Thankfully maintaining a healthy diet and exercising doesn’t have to cost a lot of money. But sometimes, a new routine, piece of equipment, or class can help motivate you.
Invest in your mental health by stimulating your mind through a workshop, conference, or weekend retreat. Exercise your creative thinking or learn a new skill outside of what you do for your day job.
Invest in your emotional health by finding a like-minded group of people to engage with or seek out a counselor or mentor who you can talk to and learn from.
Investing in yourself can pay dividends in a non-monetary fashion. But in the long run, it can help you be a happier, healthier, and more productive individual.
A final option for your taking advantage of your refund is to splurge on something that you enjoy. This makes the most sense if you are in a good financial position and are not pressed to use it for any of the abovementioned needs.
Or, consider having an 80/20 mindset. Use 80% for something from the categories above, pay off debt, save, or invest, and use 20% for something fun!
Lafayette Federal is Your Financial Partner for Life
At Lafayette Federal Credit Union, we are owned and operated by our members. This means we are able to offer competitive products and services – like higher interest rates on our deposit accounts!
As your partner, you can bank, save, invest, and plan, and receive personalized guidance and support along the way.