What to Do and Not to Do with Your Tax Refund
What are some things that we should do with our tax refund and on the opposite side of that what are some things that we should not do with our tax refund. We’ll go through four on both sides but before we do that, we just need to have an understanding about what a tax refund really is. It’s just an overpayment of your taxes to the federal government. So, over the past year basically you’ve given the government an interest-free loan. You want to try to coordinate your tax liability with what you actually pay so that you’re getting more of your money on a continuous basis and putting that to work. But if you do get a refund here is what to actually do with your refund, some smart things that you can do with your tax refund
First, either start or continue to build the emergency fund. Most people have no emergency fund at all, and lots can happen. We all know that our tires could go flat, our refrigerator could die, we could wind up paying hospital bills due to an illness or an injury. You never know what you might be able to use that extra money for and you can never go wrong with using your tax refund for emergency fund purposes. This will also help preclude you from having to use debt when these types of issues arise which most people have to go to because they have no emergency fund. Aim to have at least six months’ worth of living expenses set aside in cash accounts like money market accounts, savings accounts or even some short-term CDs. Make sure you’re looking for banks that are FDIC insured and look for ones that are offering the highest possible yields that you can make in today’s market.
The second smart thing to do with your tax refund is to pay off debt. This might not be the most fun thing to do with the tax refund but, trust me, your future self will definitely thank you. Start by making bigger payments to your debts that are costing you the most; the most toxic and costly debts you have. Remember when you’re doing so to understand the difference between what an interest rate and the total interest or what is known as the TIP. The absolute best way to make 12% on your money totally risk-free is not to have to pay it out an annual interest or finance expenses. Putting it back in your pocket and in your financial plan. Keep in mind plenty of credit cards out there are 20% or more in interest so if you’re carrying revolving debt sinking at least some of your tax refund into it could potentially pay off for you big time.
The third smart thing to do with your tax refund is to continue to boost that retirement fund. You can never ever go wrong using your tax refund to charge, recharge or supercharge your retirement fund. Get the power of compound interest working for you and the earlier you start obviously the more your savings will snowball into real wealth. A tax refund could really pay off if you invested it into your financial and retirement fund. Think about it, if an average refund is let’s say $3200 and that amount invested annually at a six percent rate of return for a 25-year cycle is right about $200,000 in retirement savings. That’s not bad for just one part of your retirement strategy.
The fourth thing smart thing to do with your tax refund is invest it in yourself. A great way to spend a tax refund is on improving your career and professional prospects through taking a professional course, getting a coach or another form of self-improvement. The greatest asset that most people possess is their ability to earn income so the idea of investing in yourself like getting certified in your industry is a perfectly reasonable plan of action. Using your tax refund to invest in yourself and in turn your career prospects and your earning potential could pay off greatly in the long run. Investing in one’s earning potential is often overlooked and undervalued in terms of a use of time and money.
Let’s go to the opposite side now we talked about some smart things to do with the tax refund let’s talk about some dumb or not so smart things to do with our tax refund. These are the four things that we should avoid doing with our tax refund.
Number one is impulsive purchases or unnecessary consumer shopping or consumer goods. Basically, you’re just buying crap you really don’t need. This can be on total consumption or spent on what we call depreciating assets such as expensive clothing, a new car, a boat or some new electronic gadget. That big TV or that new TV might look good coming in the house but it might not look so good when you don’t have enough money in your emergency fund to cover one of those unexpected expenses we talked about.
Number two is an expensive trip or dining out excessively. This is what we call the pretenders lifestyle and it’s not going to create any long-term positive outcomes. Create a budget that includes occasional treats, we’re not saying don’t ever do it but don’t blow your tax refund on unplanned vacations or expensive restaurants. Those things you they come and go and they don’t really allow you to hold on and grow the value of your money, in this case what we’re talking about your tax refund.
Next up is leaving it in a checking or savings account that earns absolutely zero interest. You are the bank’s favorite customer when you give them money expecting nothing in return. Saving your refund is a smart idea but it’s important to choose a savings vehicle that will make your money grow. Research your options and find something that works for you and your situation but don’t accept little to no interest on your checking and your savings. Remember to be saving to invest not just saving to be saving.
Finally, the fourth not so smart or dumb thing to do with your tax refund is gambling. Pretty much enough said, right? It’s understandable that you have the desire for quick and easy money, wanting to let’s say try to double that tax refund at the casino. But remember it’s very easy to lose all of it. Those casinos were not built, and they do not operate daily because everyone is winning money. You work hard for your money, don’t just waste it.
It’s ultimately up to you how you manage your money and how your money ends up helping or not helping in your journey towards financial independence and freedom. Make smart choices and those smart decisions over X period of time will equal positive outcomes. On the other hand, those continuously bad or negative decisions compounded over X period of time is going to lead you into an unknown outcome that you probably don’t want or desire.