As we have discussed in the past, if you're getting a large tax refund every year, you might want to adjust your withholdings. After all, it's your money - what's the sense in giving Uncle Sam an interest-free loan every year? (It always surprises me how many people seem to look at a tax refund as a free gift from the government.... You do realize it was your money that you earned to begin with, right? That's why it's called a "refund.")
That said, many people will receive a tax refund of some kind this year, so if you're one of those people, what should you do with that "extra" money?
Sadly, some of you probably have spent it already before it was even received. But if you would rather not let your refund get gobbled up by bills and shopping, it helps to have a plan in place ahead of time for what you are going to do with that money, and there are several things you can do with it that can actually help improve your overall financial picture in the long term.
Consumer debt such as credit cards often comes with a high price-tag; interest and lost opportunity cost add to the amount of money you owe, leaving you on the hook, and giving someone else control over your financial situation. Why would anyone want to do this? Instant gratification comes to mind, although of course real hardships do exist, but often it is simply a result of poor financial planning, and living beyond our means.
A "windfall" of cash, such as a tax refund, can be a great way to eliminate some of these debts from your life, and start with a clean slate. While it may be tempting to apply your tax refund towards that next vacation or "toy" you had your eye on, this won't put you any further ahead. If you're already bleeding money on credit card payments, freeing yourself from these payments will free up cash-flow in the long term, which you can then save for that next vacation - or whatever else your heart desires! Either way, it puts you back in the drivers seat to your financial future.
2. Start An Emergency Fund
If you've already gotten rid of your high-interest consumer debts, the next important area of your financial life is savings. Opinion varies on this, with some experts recommending you have at least 6 months of income on hand for emergencies such as short-term illness or disability, and others saying you should strive for a minimum of 2 years of income in savings. Coming from a financial planning standpoint, I'm more in the second camp, but I realize this is a longer-term goal (I'm still working on it, myself).
At the very least, to start out with, you'll want to be able to cover an unexpected medical bill or large car repair on short notice, without resorting to those seductive but dangerous credit cards. Starting out with a few thousand dollars in an interest-bearing savings account may be a wise use of your tax refund. But you'll need to be able to exercise some self-control. If you're a shop-a-holic, consider putting it somewhere that if you absolutely have to get to it in case of an emergency, you'll still have access to it, but not so easy to get to that you will spend it on the next purse or shoe "emergency" you run across. :-)
3. Fund/Overfund Your Retirement Plan
If you haven't started a retirement plan, what are you waiting for? No matter what age you may be, saving for the future is ALWAYS a smart use of your money. There are many places to save for retirement, some through an employer, and some individually. If you do have a retirement plan available through your employer, you may want to check with them about increasing your contributions when you decrease your tax withholdings - especially if your employer matches your contributions. However, if you are not getting a match, or if you're already maxing it out, you may want to consider other options. After all, most employee retirement plans are invested in the stock market, which is a risky proposition by nature.
There are lots of other options for saving. The one I use is called Bank On Yourself (learn more in my previous posts here and here), and it allows me to save and grow my money safely, while still maintaining access and control. It is growing for my future retirement, but if I need to access it in the meantime for any reason, I can still do so. Therefore, this vehicle actually serves as both a retirement fund and an emergency fund.
Depending on how these types of plans are set up, you may or may not be able to add extra money - such as a lump sum from a tax refund - to yours. However, if you've taken a loan from your plan and haven't paid it back yet, applying your tax refund towards your loan balance is a great way to replenish both your emergency fund and your retirement plan. And if you haven't started such a plan yet, you may be able to use your tax refund money to give your new Bank On Yourself policy a head start! (You can learn more about these types of plans here: www.findoutmorenow.com - for the 4-Digit Code, enter: JS35.)
You could use your tax refund for any of these purposes, and it will benefit you financially, but I suggest you tackle the ideas above in order. First, get rid of high-interest debts that may be dragging you down and keeping your cashflow hostage, then build short-term emergency savings so you don't fall back into debt if you are hit with an unexpected expense. Once these areas are taken care of, start building a solid long-term retirement savings plan that you know will be there for you when you need it.
The pleasure that comes from buying a new gadget with your tax refund money will be fleeting, but the security that comes from being debt-free and having a solid financial plan is a gift that keeps on giving. Give that gift to yourself this year, and when that tax refund money comes in, don't waste the opportunity to build a better financial future for yourself and your family.
Yours in financial health & freedom,