Ten Great Things To Do With That Tax Return – And Five Things Not To Do With It

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help!Tax season is finally over, and millions of Americans will receive checks in the mail in the coming weeks from the IRS. Although I do some consulting and other independent work (which means that I don’t typically receive a tax return at all), my parents often received a very nice return (having a low income and a lot of dependents does that for you).

In short, I learned from my parents five things not to do with your tax return:

1. Buy lots of little frivolous things. Quite often, after getting a return, my parents would take the entire family out to dinner a few times. One year, they bought a Nintendo; another year, we got a giant new television when the old one was fine.

2. Get a new car. Income tax returns often meant automobile upgrades, even if the old one was still running fine.

3. Put the check directly into a checking account “for safekeeping.” This idea was heading in the right direction, except by putting it in the checking account, it didn’t earn anything, and over time it slowly was spent on all kinds of unnecessary things until it was gone.

4. Loan it to family members. Twice, the entire return was “loaned” to a family member who just simply never repaid the “loan.”

5. Have a giant party. At least one year, my parents had a giant spring party with tons of food and drink that ate almost all of their return.

Even as a child, I knew that this probably wasn’t the best way to handle your tax return, and now as an adult, I can see even more clearly what you should be doing with a tax return. Here are ten much better options for you to use your tax return on.

1. Start (or supplement) an emergency fund. Very few Americans have an adequate emergency fund – that is, a savings account somewhere that contains money that could be used for living expenses for several months in the event of a major crisis, like job loss. Sock the return away in a high interest savings account (like the one from ING Direct) and let it just sit there until disaster strikes. This way, the disaster won’t wreck your finances – you can just go withdraw the money and it’s taken care of.

2. Invest it in a mutual fund. We have a mutual fund going so we can have our dream house at some point in the future. This is a big part of our current reasoning in our house hunt – if we buy a less expensive home now, one we can easily make the 20% down payment on, we can continue to build this fund and eventually buy a much nicer home. This is a perfect option if you have a big long term goal, like a home, that’s far down the road.

3. Start (or supplement) a Roth IRA. If you need to kick retirement saving into high gear, look into starting a Roth IRA. It’s a great way to save money for retirement without any tax issues at all.

4. Seed your own business. Roll the money into things you could use to start a side business. Not only will you be able to deduct that money next year, but you’ll also lay the foundation for another income stream.

5. Put it in a 529 for your children. Use that money to lay the financial groundwork for your child’s college education. A 529 plan allows you to easily invest money with tax-free growth for educational expenses down the road.

6. Start (or supplement) a car fund. This doesn’t mean that you should go replace your car, but merely that you’re respecting the inevitable need to replace your current automobile.

7. Do a home improvement project. Roll that money right into new kitchen cabinets, a freshened-up bathroom, repainting some rooms, or a new carpet. Home improvement projects can increase the value of your home, which is especially important if you foresee a move in the coming years.

8. Make your living space more energy efficient. Replace all of your lightbulbs with CFLs, put in programmable thermostats, air seal your home, get a blanket for your water heater (if it needs one), and so forth. Doing these things all together can significantly reduce your monthly energy bill, meaning that in the long run the money you spent will become a tremendous investment with monthly dividends on your electric bill.

9. Buy an appliance that encourages eating at home. Similar to the energy efficiency idea, purchasing an appliance (like a deep freezer or a stand mixer) that can encourage you to eat at home more often will gradually reap rewards over time, as you begin to prepare food at home. A deep freezer is one of the first investments we plan on making when we have our own home, because we can prepare many meals well in advance and merely pull them out and toss them in the oven in the evening.

10. Buy individual stocks. You could even take the money and start an individual stock investment account. This is a good way to get very familiar with the stock market and individual stock investing, though it is not something I actively pursue at this point. Remember, though, that individual stock investing carries substantial risk – but has the potential for substantial reward.

The moral of the story? There are a lot of things you can do with your tax return that can set you on a strong financial path. Don’t let this little financial boon convince you to do something unwise with your hard-earned money.

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17 thoughts on “Ten Great Things To Do With That Tax Return – And Five Things Not To Do With It

  1. Your blog is excellent, Trent, and I’ve become a daily reader. Thank you so much for the effort you put into it day in and day out. Great stuff.

    Just a minor nitpick: When you say “tax return” in this post, I think you really mean “tax refund.” “Return” is the 1040 form you file so that you can receive your refund.

    Otherwise, rock on! :-D

  2. Lots of great suggestions, especially the eco-friendly ones. But watch out for that dream deepfreeze! It is incredibly tempting to keep adding food, and requires a great deal of discipline to consume it. If you are not careful about labeling the dates and contents (which is a huge pain!) pretty soon you lose complete track of what is in the freezer. But definitely invest in some great knives. They save a lot of time in cooking and make it much more pleasant.

  3. Just starting reading your blog, love it and love your thoughts. I have done one of the things on you top 10 list of things To Do, we put our tax return in HSBC and its earning 6% till the end of April, then we will use it for our trip to Euro-land.

    c

  4. This sounds so much like eating your vegetables vs. eating that oh-so-tempting Milky Way. I suppose most personal finance conundrums can be compared to that, though.

    Great ideas to think about while I await my return.

  5. What’s wrong with taking your famiy out with some of the tax money? Esp if it’s the only way your parents could afford it? We are also on a very extreme( we have 4 kids and one income and it’s not that great but we have good benifits). And our tax money is the only time we can take our kids out and go to a nice resturant with real tablecloths and such. We consider it a lesson on the “real” world. You know, napkin goes in your lap, what all those glasses/forks are for, NO, you may not crawl under the table to get the fork, the server will bring another, etc. As for the “frivolous” things, were you not thankful for that Nintendo? Or the new TV. Your parents had a hard burden( I know, I’m there) and it made them feel good to throw a party and buy a toally useless thing or two.
    We aso have been known to do silly things with the return. But, we have two months in the bank, our bils are paid, food is the fridge, clothes are out our backs, you get the point. Sometimes getting new stuff and throwing a party keeps you going as a human. Makes all that work worth it.

  6. Number 5 is a great solution for split couples with a kid. To avoid fights with my son’s mom about who gets to claim him or coming up with complex math equations to figure out how we should split the claim, we decided that I will claim him (I get more money back from the tax man) and then use that money to fund a 529 for him. Seems only proper since he is the reason I am getting the money back anyways.

  7. I noticed that you didn’t have “Pay off debt” as one of the 10 things to do with your refund. Is there any particular reason you chose not to suggest that?

  8. Dustin: Yes. Using unexpected money to pay off credit cards rarely solves the underlying problem. I would never use an unexpected windfall to directly pay off debt.

  9. Putting money into individual stocks is gambling which is worse than any of your 5 “don’t dos”. You may get lucky and make money but it is just as likely you will earn nothing. Even if you have years and years of training, your odds are slim to beat the general market. This has been shown in studies over and over and over again.

    You will likely learn a valuable lesson if you do buy individual stocks, I learned mine, not to do it ever again.

  10. Funny thing is that people think tax returns are some kind of second pay check for a month, when really you just didn’t set up your W2 forms correctly at work.

    I guess you could think of it as some sort of short term savings tool, but really it’s not.

    And it should be used to pay of credit in the respect that you paid too much for taxes in your check (see previous paragraph). Next year, maybe you’ll redo your W2 and have a better budget.

  11. I’m currently living in Europe, with no income, aside from student loans (I AM a student, and I AM getting college credit for being here. Don’t worry. I’m not wasting your tax dollars). But my tax refund is giving me an extra month here. Not the smartest way to spend it, probably, but might as well use it while I’m here…

  12. Doing something fun is fine as long as you are aware where you are spending money. If you are getting a refund, you have a tax planning problem anyway, and are loaning YOUR money to the government so they can return it to you w/o any interest paid! Suckers.

  13. One correction: your tax “return” is the form you fill out to tell the gummint how much you made and how much you owe, and you try to be as accurate as you want to be. The money you get back, perhaps as a result of some creative thinking, is your tax “refund”.

  14. and at the top of that list could be PAY OFF DEBT first! It’s hitting harder than what you could invest in~ :)

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