American Dream

Discretionary Income: 5 Smart Ways to Spend It

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If you are among the 80 percent of American tax filers who receive a tax refund each year, you may be wondering how to best spend that discretionary income. The average tax refund is nearly $3,000, and it can be tough to know how to spend such a chunk of change. This is especially true if you know that you’re unlikely to see another large lump sum until the next tax season.

The key to spending your discretionary income wisely is to think of your purchases as investments toward your financial future, your family, or your home. Here are five smart ways to invest your tax refund — and reap some big rewards.

1. Pay Off Debt

This is probably the least fun way to spend discretionary income because you won’t have anything tangible to show for it. But paying off your debt offers one of the best returns on investment. For example, if you are paying 15 percent interest on a $3,000 credit card balance, paying off the debt means that you will owe $450 less on the credit card over the coming year. If you can’t pay off a balance entirely, putting some money toward it will help lower your future payments and remaining balance.

2. Meet With a Fee-Only Financial Planner

Over one-third of Americans are not saving for retirement, and that is partially because many simply don’t know how. Even if you have started saving for retirement, you may still feel overwhelmed and unqualified to make the decisions that will provide you with a secure future. Investing your tax refund into meeting with a fee-only financial planner can help you to define and start working toward your financial goals. Generally, you can expect to pay between $100 and $150 per hour to meet with a fee-only planner. The money you have left over after paying your adviser can be put directly towards your retirement savings. You can find a fee-only planner in your area at napfa.org.

3. Open a 529 Plan for Your Child

A 529 plan is a college savings account that will grow tax-free. Withdrawing from the plan is also tax-free, provided that the money is used for qualified education expenses. A one-time $3,000 investment in a 529 plan with an 8 percent return will grow to $6,477 in 10 years, $9,517 in 15 years, and $11,988 in 18 years. That growth will be even more impressive if you commit to putting each year’s tax refund into the 529 account.

4. Invest in Your Home

Your house is your single largest asset, and it can be easy to fall behind in maintenance and upkeep. Using your discretionary income to improve your home can potentially help you lower utility costs and raise your property’s value. In particular, spending your tax refund on windows or insulation can help lower your heating and cooling costs, which will improve your bottom line throughout the year.

5. Take a Vacation

There is nothing more important than your relationship with your family. Spending your tax refund on a fun (and affordable) vacation is a great way to reconnect with the people you love most. You will come home feeling refreshed and energized, which will help you improve your performance at work, your kids’ grades in school, and the relationships with those around you.

When you have discretionary income, such as a tax refund, think twice before you go out and purchase something you’ve been lusting over. There are quite a few other options that will give you a higher return on investment.

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Emily Guy Birken is a former educator and respected personal finance writer. She is the author of the best-seller The Five Years Before You Retire, and the forth-coming book Choose Your Retirement. Her work has appeared on Huffington Post, Yahoo Finance, Business Insider, MSN Money, and Kiplinger's, and Birken has been a guest on Wisconsin Public Radio as well as several podcasts, including Stacking Benjamins and The Doughroller.Birken's background in education allows her to make complex financial topics relatable and easily understood by the layperson. Her mix of no-nonsense advice, humor, and research into the latest studies on finance and behavior make her work a go-to resource for anyone hoping to get a better handle on money matter.