Over the past few weeks, many people have started receiving their tax returns if they filed their income taxes early in the year.
It can be an exciting time, particularly if your income tax refund check is the largest check you receive all year. One member of my family gets a check that’s about four times his normal weekly paycheck when his tax return comes in.
With that kind of cash in hand, it can be really tempting to splurge on something. I’ve seen people buy ATVs, televisions, computers, clothes, jewelry, and other such frivolous things with their check. Another person I know uses his check to go on a trip.
Here’s the reality, though. If you ever want to put yourself onto firm financial ground, you cannot afford to treat your tax refund check like a Christmas present.
Yes, it’s fun to splurge. Sure, it’s great to buy something big and flashy. The problem is that after you’ve spent the money, your life is right back in the same place where you started except you now have an overpriced toy.
If you were facing debts before, you’re facing them now. If you were struggling to escape a paycheck to paycheck loop, you’re still struggling. If you were spending restless nights tossing and turning because of your worries about your bills, blowing your income tax return isn’t going to help you sleep. If you felt like financial security was just a dream, it’s still going to be a dream after you blow your tax check.
Spending your tax refund on improving your financial situation might not be flashy, but it will have a far greater lasting impact on your life. This is particularly true when you couple it with a personal commitment not to undo the positive effects of the tax refund in your life.
Here are four things you can do to turn things around with your tax refund. Yes, they’re not fun, but they will help you breathe easier at night, lower your stress level, and perhaps help move you away from a paycheck-to-paycheck cycle where you’re tied to your job.
Pay off some debt. American Debt Advisor estimates that about 80% of Americans are carrying some form of debt. Debt has a lot of negative consequences in your life: it’s an extra monthly bill, for starters, and you often have to repay far more money than you borrowed.
Use your entire tax refund to pay off some debt. Find a debt you can pay off entirely and simply pay it off. Just like that, a monthly bill disappears. If you can’t do that, throw all of it at whichever debt has the highest interest rate.
At the same time, commit yourself to not building up any more debt. Simply make a rule for yourself that you’re not going to increase your debt load, no matter what.
Build an emergency fund. An emergency fund is simply cash you have easily available (such as in your savings account) so that when an emergency happens, you can just pay for it without getting into debt or having to make hard choices. Everyone loses a job or has a car break down at some point in their lives. An emergency fund keeps that kind of thing from being a disaster.
Just stick the check in your savings account and forget about it. You can then sleep better at night knowing that if something disastrous happens, you can just deal with it without skipping a beat.
Commit yourself to not touching that money for anything other than a real emergency. A real emergency doesn’t mean poor planning, either.
Save for your children’s education. You can sock that money away in a 529 account for your child. A 529 account is a special type of savings account with many additional benefits for educational savings. It’s pretty easy to set up – if you’re unsure, go to Google and search for “best 529 account” to find out the specifics.
Put the check into the 529 account, then forget about it. While it won’t cover your child’s education, it will certainly provide a very big help down the road when that child chooses to go to college.
It’s one less thing for you to worry about.
Save for your retirement. You can essentially repeat what I said above, except that you’ll be saving your money in a Roth IRA for yourself instead of in a 529 for your child. The vast majority of Americans are eligible for a Roth IRA, which is essentially just a special account with tax benefits for retirement. When you start taking money out of that account when you’re retired (59 1/2 or older), all of it is tax free.
Again, just put that money right into an account. If you’re overwhelmed by the setup, don’t be afraid to contact a fee-based financial advisor with questions. Again, one less worry in your life.
If you have all of these bases covered, you’re in better shape than the vast majority of Americans and you likely already have a good plan for that money. If you don’t, strongly consider using your return for one of these options. It won’t provide a short-term good time, but it will significantly lower your stress and improve your peace of mind over the long run.