How to Spend Your Tax Refund the Smart Way

You know the wise financial decision is to save your tax refund. But even high-yield savings accounts have fairly abysmal interest rates. So, how should you save your tax refund? Depending on your financial situation, spending it may be a better option. Read on to discover five smart ways to spend your tax refund.

1. Buy Your Financial Freedom

Arguably the smartest way to spend your tax refund is to start paying off unsecured debt, such as credit card debt. There are several schools of thought about whether the debt snowball, debt avalanche or debt waterfall debt repayment technique is best. Mathematically, the debt avalanche, or making minimum payments on all but the highest interest rate debt, will save you the most money in the long run.

When you get your tax refund, at least a portion of it should go towards making a payment on your debt with the highest interest rate. Just make sure you keep making the minimum monthly payments even though they won't be required for the next several months.

2. Buy Yourself Peace of Mind

Nothing helps you sleep better at night than knowing you have the cash on hand to handle a small emergency. If you don't already have a $1,000 emergency fund, use part of your tax refund to get yourself there. Just remember that this money is only to be touched during an emergency to keep you from going further into debt.

3. Invest in Your Future Self

You probably understand the power of compounding interest from reviewing your credit card bills. Allow compounding interest to work for you by starting or adding to a traditional IRA. With a growth rate of just 7.18%, your money will double every decade. If you invest $3,000 at 35 years old, you would have $24,000 growing tax-free by the age of 65.

While this certainly isn't enough to retire off of, if you invest just $3,000 every year for 30 years, you will have nearly $340,000. If you only withdraw 4% of your portfolio, you will have over $1,100 a month to live on excluding any social security income or pension benefits you receive.

4. Prepay Your Mortgage

Because so much of your mortgage payment goes to interest during the first seven years of a traditional 30-year mortgage, reducing the principal will save you thousands of dollars in interest over the life of your mortgage.

5. Buy Life Insurance

If you have a partner, parent or child who depends on you financially, now is the perfect time to start looking into a term life policy. We'd all like to think that we don't need to worry about life insurance for many years to come. However, nobody actually knows when the unthinkable will happen. While a whole life insurance policy can cost a healthy, non-smoking 35-year-old $200 to $300 a month, a term life policy with a $250,000 face value can cost you as little as $20 to $30 a month.

Spending your tax refund on a new TV or two-week vacation can be tempting. But the smartest ways to spend your tax refund are to buy freedom from debt by paying down unsecured loans, buying peace of mind by bolstering your emergency fund, investing in your future self through a traditional IRA, prepaying your mortgage and protecting your family by buying term life insurance.