It's difficult to find anything nice to say about tax season, but if there's any silver lining to this often stressful time of the year, it's that it is immediately followed by tax refund season.

If you're one of the millions of Americans who have received, or are due to receive, a massive tax refund, pour yourself a cup of coffee (or, you know, tea) and get comfortable. Because we'd like to spend a little time with you today talking about the smartest ways to put that check to use … and a few tax-refund pitfalls to avoid.

The Tea

If you're a typical W-2 employee, part of every paycheck will go toward a number of line items, such as 401(k) contributions, health care premiums, and, of course, taxes.

Wish though we might, employer tax withholding is far from an exact science. 

Everyone pays the same percentages on Medicare and Social Security taxes, so those are usually withheld correctly. However, depending on your federal tax bracket, you might owe anywhere between 10% to 37% of your income; your state taxes likely will vary depending on your income, too. And while your employer will try to withhold an appropriate amount, they can only do so based on the W-4 and state withholding form you submit—helpful in broad strokes, but hardly laser-precise.

WealthUp Tip: Haven't filed yet? If you think you won't make it across the finish line in time, here's what you need to know about filing a tax extension.

As a result, your employer likely withholds too little or too much. 

If it's the former, you'll have to settle up with the IRS (and consider resubmitting your W-4 to withhold more in the coming year). But if it's the latter, you're in for a sweet surprise—a check or two from the U.S. and/or state tax authorities, sometimes of considerable size.

For instance, so far in 2024, the IRS has issued an average refund of $3,182—5% better than what taxpayers received last year. It's a very meaningful sum for most—a sudden influx of money they never budgeted for, and that could be put to any number of uses.

But some uses can have a much bigger positive impact on your personal finances than others.

To help our readers put together a money-smart game plan for spending this and future tax refunds, we've reached out to Thomas Racca. Racca is the personal finance team manager at Virginia-based Navy Federal Credit Union—the largest retail credit union in the U.S., with more than 13 million customers and over $170 billion in assets.

The Take

They call it "personal" finance for a reason: every person's financial situation is different from the next, whether that's the size of your refund check, your budget, whether you have debt (and how much), and what's important to you.

That said, Racca offers up a general ordering of how tax refund money can be used most effectively—whether it's shoring up your finances, building wealth, or just enjoying it.

The Best Ways to Spend Your Tax Refunds

The idea here is pretty simple: This is a general prioritization list. If you have the first area covered, move on to the next.

1. Emergency Fund

No surprises here. You can bet that if you ever get any sort of sudden influx of money, most financial minds (including us!) will recommend that you start by setting up an emergency fund.

WealthUp Tip: Looking for other ways to save your way to an emergency fund (or another goal)? Consider these tips.

"About half the country couldn't handle a $1,000 financial hardship out of pocket, so if you come into a four-figure check, that immediately puts you ahead of 50% of your peers," Racca says. "The size of the emergency fund—$500, $1,000, $5,000—depends on your living expenses, your income, and age, among other factors."

2. Pay Off Debts

"Once you have a reasonable emergency fund," Racca says, "Step 2 is getting out of debt."

Generally speaking, if you get a windfall—whether that's a tax refund, a gift, or even an inheritance—and you're trying to decide between paying off debt or investing the money, you go by rates. If your debt has a higher rate than what you could reasonably expect to earn in the stock market (or whatever investment you're comfortable with), then you should pay off the debt.

And if you're paying off debt, you want to focus on debt carrying the highest interest rate—usually a credit card.

"The average interest rate on a credit card is going to be in the low to mid-20s (percent). And if you had a lower credit score when you originated the debt, you could be paying in the high 20s or low 30s—especially if you've had a financial hardship and triggered default pricing," Racca says. "You will never earn that even if you're a savant in the stock market. That just doesn't happen."

Of course, if you are paying off debt, Racca suggests going the extra mile and becoming more mindful about your debt habits, too. Credit cards, payday loans, buy now/pay later (BNPL) … a lot of these unsecured lines of credit become popular options around the holidays. 

"It's very inviting to look and see that you can pay something off interest-free in four installments. And it can have a place if you're a financially responsible individual," Racca says. "But if it's abused, or overleveraged, it can go from putting one thing on layaway to becoming the way you finance your grocery shopping, or book vacations, or handle emergencies—things that should just be baked into your regular household budget."

3a. Invest It

From there, Racca says, you want to take a step back and examine how much you have left, and determine whether you want to spend the rest of that money to make yourself feel more comfortable now, or more comfortable in a few years.

WealthUp Tip: Even if your tax refund isn't that generous, it's easier than you think to invest even a little money.

"There's something to be said for rewarding yourself and throwing a little bit into a hobby or trip," he says. "But you're going to see a lot more long-term gratification if you put it right back into the market and let it start generating passive income."

There are two ways you can go about investing your tax refund:

• Directly: This means simply taking your check and funneling that money right back into a brokerage account or a non-workplace retirement account (like an individual retirement account, or IRA). If you do the latter, be mindful of IRA contribution limits.
• Indirectly: Now that you suddenly have extra money on hand, you can offset it with a larger-than-normal one-time contribution to a workplace account, such as a 401(k), 403(b), or even a health savings account (HSA) if you invest through yours. This is a great way to squeeze a big tax advantage out of your IRS refund.

3b. Cross Something Off Your To-Do List

"Have you been waiting on a car repair? A home upgrade?" Racca asks. "Leveraging your refund to a project can free up some mental stress, add equity to your home, or keep a minor repair from becoming a major one!"

4. Say "Thank You!"

There's also nothing wrong with making the world a little better for someone else.

"Use a small piece of your refund to treat your babysitter, parent, or neighbor that helped you out with your last home project. Take a friend out for a coffee. Maybe consider leaving a generous tip for your waiter the next time you go out," Racca says. "A little thank you might cost you a few bucks, but it will likely mean the world to someone to show you are thinking of them!"

What Not to Do With Your Tax Refund

Importantly, this is your money—which means you can do pretty much whatever you'd like with it. That's doubly so given that this is money you probably didn't budget around.

Still, there are certain ways of handling your tax refund that could actually come back to bite you, or at the very least hinder your plans to make the most of your windfall.

1. Don't Put It in an Account You View Every Day

If you put your money into an account you see each and every day—a checking account, a regular savings account—you'll be increasingly aware you have these funds available … and be more tempted to spend it. 

"When you're scrolling through Amazon, Instagram, you see an ad, something you might scroll by ordinarily because you don't have the funds, but now you have the opportunity to make a bunch of impulse purchases. These purchases could become normalized quickly and eat up your funds," Racca says.

Instead, he suggests, if you don't have a credit card bill to pay off, or a trip you want to plan, but you want to keep the money handy for something big in the future, the best thing you can do is put it into an account that takes at least an extra step or two to access, like a money market account. Or, if your bank allows for this option, you can segment off your tax return funds so they don't roll into your normal online banking view. "Either way, when something comes up, if the goal is to hold on to it, that's not in front of your eyes every day."

2. Don't Start Picking Up the Tab Everywhere

While it can feel great to use a little of that money to treat a friend to coffee or the family to dinner, don't overdo it—lest you pick up a habit you can't afford to continue.

"One of the most common pitfalls we see is that, sometimes you'll have family members or friends that want to invite you out, and that money quickly burns a hole in your pocket—you say 'I'll buy this round' or I'll pick up dinner.' You have the money there. It's in your pocket," Racca says. "But the next thing you know, you're trying to live outside your means, do more for others, and while it feels good in the moment, we hear pretty regularly about these actions eating up a windfall."

WealthUp Tip: Another way to keep from overspending? Look out for the signs of "drip pricing."

It's a phenomenon that leads Racca to also warn against lifestyle creep.

"Keeping up with the Joneses is very real," he says. "One of the things we see very frequently is your income is not indicative of your financial independence. More money really can equate to more problems. As you get more money, if you don't continue to try to live at a lower means, then the habits that get one into financial trouble will eventually get you."

"If you spend 100% of your income at $50,000 a year, you'll probably do it at $100,000 or $200,000 a year. There has to be a change in outlook, approach—a willingness to manage your money differently and live below your means."

3. Don't Think of a Tax Refund as a Windfall

Guilty! I've said the word "windfall" several times already, and I've generally spoken about a tax refund like it's the IRS stork dropping a ruby-cheeked bundle of cash at your doorstep.

It is that, in a way … but it's also not.

"A tax refund is your money," Racca says. "It was pulled out of your paycheck, as an overage, every two weeks as you got paid."

In other words: This was money that you could have been receiving the year, but that you weren't because of faulty withholding.

"While it's nice to have the check, look back at your spending [over the past year] and think about times you were $100 short for a car payment, groceries, rent, or anytime you swiped a credit card because you didn't have cash on hand," Racca says. "These are all times, where if your taxes were withdrawn properly, you would've had that cash in hand, you'd have that money in your pocket, you wouldn't have incurred debt, etc."

His advice? Work on submitting a new W-4 that will withhold the proper amount throughout the year, ensuring you're not giving too much (or too little) money to the IRS.

"I would encourage anyone in this position to sit down with a pen and paper, and try to get as close to zero [tax refund] as possible."

Thank you once again for reading! Have a great weekend, and enjoy the Final Four!

Riley & Kyle

WealthUp (Young and the Invested is now WealthUp)

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