How to Use Your Tax Refund Wisely
Tax season is often stressful and confusing, but for some people, it also means getting back an overpayment you made to the government. While it may be tempting to splurge on a vacation or new gadget with this extra cash, planning to wisely use your tax refund can have long-term benefits for your financial future.
Whether you are considering how to use your tax refund wisely or just wondering what to do with a lump sum of cash you have acquired we recommend that you always start with the steps below. Find where you are on the steps below and begin by using your tax refund there.
Apply These Time-Tested Principles When Deciding How To Use Your Tax Refund. (In Order of Priority)
Financial wellness begins with quitting your dependency on debt to fund your lifestyle. You can use your tax refund wisely by working thru these steps in order to become debt free.
1. Establish an Emergency Fund of $1,000
If you don’t have an emergency fund in place of at least $1,000 in a separate savings account you will find it very difficult to quit your dependency on using debt as your security blanket. Without an emergency fund, you’ll be too tempted to reach for the credit card with the car that needs a repair or your refrigerator gives out. The first priority for your tax refund is to make sure you have an emergency fund in place.
2. Start your Debt SnowBall
Do you have step 1 already completed? Congrats! The next priority is to use your tax refund wisely by starting your debt snowball. A debt snowball is a way to pay down your debts quickly and build momentum along the way. Start by listing all of your debts except for your mortgage. Put them in order by balance from smallest to largest—regardless of interest rate. Pay minimum payments on everything but the little one: attack that one with a vengeance. Once it’s gone, take that payment and put it toward the second-smallest debt, making minimum payments on the rest. That’s what’s called the debt snowball method, and you’ll use it to knock out your debts one by one.
3. Use it to Build A Fully Funded Emergency Fund
Already debt-free? Woot Woot! Great job. Now that you are debt-free it is time to build a full emergency fund of 3 to 6 months of expenses so that you are insulated from the loss of a job or even if you have to buy a new car unexpectedly. If you have steps 1 and 2 completed, the best way to use your tax refund wisely is to apply it to your full emergency fund of 3 to 6 months of household expenses.
4. At the Same Time, Invest, Contribute, Pay
If you already have steps 1-3 completed let’s start to do these 3 things simultaneously. Any of these three things is a great way to use your tax refund wisely.
Invest in Retirement
Begin investing 15% of your gross household income to retirement in the following order of priority.
- Take advantage of your employer’s 401K match to the fullest first. If they will match the full 15% go for it. If they’ll only do 3.5% take advantage of it. It is free money. We like free.
- If you still need to invest more to get to 15%, open a ROTH IRA for yourself and your spouse, if married.
- If you still need to invest more to get to 15%, open a traditional IRA with a broker you trust.
Contribute to the College Fund
While you are investing 15% into your retirement accounts, begin to save for your children’s college education. Consider opening a 529 plan in your state which allows for tax-free growth on your college savings provided they are actually used to pay for college.
Pay Your House off Early
Use your tax refund wisely by using it toward paying off your home early. Apply any extra money you can find or that comes your way, like a tax refund for instance. You can use your tax refund wisely by using it to help pay off your house ahead of schedule.
5. Give, Save, Enjoy
If you are debt free including your home, it is time to build wealth and be generous. When you get extra money from a tax refund or perhaps an inheritance a great way to use it once you are completely debt free is to assign a percentage to these three priorities.
In this step, you’ll use your tax refund to accomplish 3 things. Give some of it away, save some of it, and enjoy some of it. How do you know how much for each category? We like to assign a percentage to any extra money that comes your way, like a tax refund for instance. When you are in this step, you are completely debt free including your home and you are investing in retirement and your children’s education. So extra money that comes your way can be given priority according to a percentage to each of the 3 categories below.
Give a %
Assign a percentage to give away as a blessing to someone else. Is there a charity close to your heart? What about around the holidays to make a child’s Christmas more bright? And don’t forget, for our faith-based friends, to tithe some to your local church.
Save a %
Assign a percentage to save/ invest. You could assign a percentage to your retirement or just for some extra emergency fund protection.
Enjoy a %
Assing a percentage to enjoy. Finally, when you have some extra tax refund money in your pocket, don’t forget to enjoy some of it. That is assuming of course that all of the previous steps outlined in this article have been completed.
Better Yet, Don’t Overpay the Government
While it is fun to get a big check in the mail at the end of tax season, it is also a reminder that you OVERPAID your taxes. A tax refund is also known as a free loan you gave to the government. The best plan for your taxes is to not owe or pay at the end of the year.
Why Did You Get a Tax Refund?
Each US taxpayer has a right to pay only the amount of tax due. No more and no less. You are getting a refund because you had too much withheld from your paychecks in advance. That equals a free loan to the government.
Is it Possible to Break even on Taxes Each Year?
According to Ramsey Solutions, you can calculate your tax withholding to get close to breaking even. Although it will take some work and advanced planning to do this, it is worth it because your checks will be bigger throughout the year so you’ll have more money in your pocket all year long. That is a good thing.
What Should I Do with My Tax Refund?
Go straight to the top of this page and follow the steps in order of priority. Do this with any lump sum of money you receive.
Final Thoughts on How to Use Your Tax Refund Wisely
Getting a tax refund can be fun, but knowing how to use your tax refund wisely will set you up for future success. In fact, any time you receive a lump sum of cash applying the principles above in order of priority will assure that you are not spending it unwisely.
Once you are debt-free, you should always be doing 3 things with extra money. 1. Give a percentage away. 2. Save a percentage. 3. Enjoy a percentage and improve your life.
Knowing how to use your tax refund wisely will keep you from making mistakes with your money and improve your life.
