Receiving a tax refund is no cause for celebration. Not only was it your money to begin with, but you most likely need to make adjustments on your W-4 or federal income withholding allowances. Withholding too much from your paycheck throughout the year is providing the government with a nice interest free loan. More importantly, that money could be working to earn you interest. A lump sum of money is always a nice thing though, regardless of whether it was expected or unexpected. With that being said, your money is valuable, and just like your paycheck each dollar of your refund should be given a purpose.
1. Contribute to your emergency fund
Planning for unfortunate events (flood, fire, illness is never fun but it can save you from financial disaster. It is recommended to have at least three months of cash to cover your expenses in trying times. Some financial experts recommend having closer to a year’s worth of cash.
2. Pay off your debt
If you have any amount of debt, it should be your priority to pay this off first. Cutting expenses and paying of every dollar of debt can be difficult, especially when your budget is already tight. Channeling a windfall such as a refund into your debt can really make a dent. Paying off your debt should be done before building an emergency fund as it is costing you money in interest each month as well as eliminating the option of charging items if times get tough.
3. Save more for retirement and other goals
It should be common practice to channel as much money as possible into investments. This is especially the case when you receive a fairly large amount of cash. It is said that the average American is not investing enough in their retirement. It is recommended that at least 10% to 15% of your annual income should go towards your retirement.
4. Refinance Your Mortgage or Make Home Improvements
If you are looking to buy your first home and you are financially ready, a refund doesn’t hurt to have. There is no better time to buy with mortgage rates being at all time lows. If you already own your home, refinancing can allow you to take advantage of these low rates and you can use your refund to pay for closing costs and fees. The money saved in interest alone with give you a return on your money immediately. Additionally, investing in your home is one of the quickest ways to add value and gain functionality out of your home. If there is a project that you have been putting off, a refund may be just what you need to make it happen.
No matter what your refund is eventually used for, it should be treated with the same consideration as any other dollar that is earned. Whether your refund was expected or not, it should be used in the way that is most advantageous to wherever you are in life. Ignore the urge to go out and blow your refund and consider how you can really make it work for you.