How to Turn Your Tax Refund Into a Fortune

The average tax refund for 2023 is $3,182, according to the latest IRS data. If you're getting a refund, you may be tempted to use that money on a splurge. But if you're willing to keep your hands off that money for a while, you could watch it grow into a substantial nest egg.

It's surprisingly easy to turn your tax refund into a small fortune, even if you don't have any investment experience. We'll walk you through exactly what to do to watch your money grow.

Finding the best use for your refund

Before we talk about how to invest your tax refund, let's address an important question: Should you invest your tax refund?

If you have credit card debt that's accruing interest, it's smart to apply your refund to your balance. Due to high credit card interest rates, you'll probably pay more on your balance than you'd expect to earn from the stock market in a typical year, so it's best to tackle that debt first.

Also, if you don't have an emergency fund that could carry you for three to six months, consider putting your refund into a high-yield savings account. An emergency fund protects you in case you lose income or face a major unexpected expense. Because you don't want to sell investments at a loss if your bad luck coincides with a stock market downturn, it's best to focus on your emergency fund before you invest.

How to turn your tax refund into a fortune

If you don't have high-interest debt and your emergency fund is in good shape, opening a Roth IRA is a great way to use that tax refund. You don't get an upfront tax break on your contributions, but your money grows tax-free -- which is a worthwhile tradeoff for many people, given the potential for an investment to compound over time.

The S&P 500 index, which represents about 80% of the value of the U.S. stock market, has historically delivered average annual returns of about 10%. Some years, the index smashes way past the average, while in other years (think 2022), the index finishes down. But over long periods of time, it produces pretty reliable returns. Here's how a $3,000 tax refund invested in one of the top S&P 500 index funds could grow over time, assuming 10% annual returns.

Of course, this assumes you don't contribute an additional penny. But you'll see the value of your account skyrocket if you get in the habit of making regular Roth IRA contributions. Even if you can only kick in $50 or $100 a month, that's a great start. You can aim to save more any time you get a raise or a surprise windfall until you hit the annual Roth IRA contribution limits.

Should you be getting a tax refund?

There's a lot of debate in personal finance about whether getting a tax refund is a good thing. It's true that when you get a big tax refund, you've given an interest-free loan to the U.S. government. But on the other hand, some people who struggle with budgeting find that a tax refund functions as a sort of forced savings account, making it easier to stash away money.

One option is to adjust your tax withholdings so that you'll more or less break even when you file a tax return. You can then set up automatic transfers to your Roth IRA or high-yield savings account so the extra money you're getting in your paycheck goes directly into the account. Use a budgeting app if you need help deciding how much to save out of each paycheck.

The best approach is whichever motivates you to save more. Giving the federal government an interest-free loan isn't ideal. But if getting a big infusion of cash once a year is more helpful for your financial goals than getting a little extra from each paycheck, go ahead and do what works for you.