If you’re expecting a tax refund this year, you need a good plan for your money. Maybe you already have the funds earmarked for some spending, but before you let your tax refund burn a hole in your pocket, remember that the government isn’t sending you a bonus check – it’s money that should have been yours all along. In fact if you’re receiving a huge refund, you’re probably having too much withheld. Be sure to revisit your W-4 form and adjust your federal income tax withholding allowances.
Don’t get caught treating your refund check any differently than you’d treat your weekly or monthly paycheck or if you own a small business, revenue from your customers. Give the money a purpose. Don’t just let it sit in your checking account. If you do, it will quickly vanish after you use it for dining out here, shopping for clothes there, and getting Starbucks every day. Before you know it, you’ll have nothing to show for the refund.
Think about your personal financial situation, and figure out your needs. To get you started, consider this hierarchy of financial priorities, from the fundamentals to advanced strategies.
Top 10 Priorities for Your Tax Refund
1. Start or Increase Your Emergency Fund
Without an emergency fund, just one surprising piece of bad news can send you on the debt spiral to financial disaster. Most experts say that your fund should have about six to eight months worth of savings in an easily-accessible interest-bearing account (e.g. savings account or money market account). Storing that much away might take months or even years if you’re just taking a little bit out of each paycheck, so use your refund to make a significant deposit in your emergency fund.
2. Pay Off High-Interest Debt
After establishing an emergency fund, the next best thing you can do with your tax refund is to pay off any high-interest debt that you’re carrying. If you have a lot of debt, just putting money in savings is like borrowing money from yourself. Put your refund to work by establishing clear goals and starting your own debt elimination program.
3. Spend It on Something You Need
Are you having car trouble, do you need a new winter coat, or have you put off dental work? You need to take care of these essentials, and now that your refund is here, you can cover the cost.
4. Start Itemized Savings Accounts
Now is the time to start practicing the mindset of the disciplined and frugal consumer. First make a budget, and then break your refund into pieces, each of which plants the seed in your bank account for important future purchases. Putting your refund toward specific savings goals will keep you from taking on debt down the road, when needs or desires arise. The AFCB Online Financial Management program offers some great features that allow you to set up these specific savings goals in your account.
5. Refinance Your Mortgage or Make Home Improvements
Mortgage rates are below 5% for the first time since the housing boom, except this time the price of homes is far less than they were in 2004. When you refinance your mortgage, you will still pay closing costs and fees. Use the refund to pay for the closing costs, and you will save thousands of dollars per year on mortgage interest.
If you’re happy with your mortgage rate, take a look around the house. Do you need a new roof? Is your kitchen outdated? Could new energy-efficient appliances save you money on your utility bills? Home improvement projects can immediately increase the value of your property and make your home more comfortable at the same time. If you need more money than your refund covers, consider supplementing it with a home equity loan.
6. Invest in a Tax-Sheltered Account*
Depending on your income level, goals, age, and whether you have already fully-funded your tax sheltered accounts, using your tax refund to get a head start on Roth IRA contributions or 529 college savings plan contributions is a great move, one that can let your three-digit tax refund grow into to a four-digit addition over the course of a few years. Plus, it’s like using your tax refund to create a tax deduction ... sound like a plan? Contact the AFCB Investment and Retirement Services division and have a discussion about how to best use your refund.
7. Invest in a Taxable Account*
Have you already contributed the maximum to your tax-sheltered accounts? Give yourself a pat on the back and consider opening a brokerage account with a discount broker (e.g. AFCB Investment and Retirement Services). Lean toward conservative and diversified investments with low expenses. Check out some mutual funds. Index funds or ETFs may be a good choice for you, especially if you are not interested in actively managing your stock portfolio. They offer instant diversification and very low expenses.
8. Give to Charitable Causes
For many people, giving to charities is non-negotiable, and would be priority number one. But on a tight budget, donations can unfortunately slip down on your list. Your refund is your chance to give a little back. Contributing to charity is an excellent use of capital, and provides a huge societal benefit. Choose a cause that is important to you and your family, and give generously. Although the returns on your investment may not be as immediate or measurable as investing in the financial markets, giving to charity will benefit your community in a major way, and you can claim the tax deduction too.
9. Get that Business Up and Running
Have you been looking for seed money to take your business to the next level? Do you have a venture that you want to start? You can use your refund to get you moving in the right direction. It’s a great opportunity to turn your refund into income for years to come, and get a few more small business tax deductions next year too.
10. Spend It on Something You Want
If you made it to priority ten and still have some money left to spend, so you deserve a treat. You saved all year, and now you’ve earned the right to splurge a little bit. Don’t feel guilty about using the extra cash for a summer vacation or to treat your family to a nice dinner. Just don’t let your eyes get too big for your stomach. A $500 refund is no excuse for a $3,000 trip.