Tax season is a beautiful time of the year where virtually everyone is anxious about how much of a refund they’ll be getting back. Unfortunately, the truth is a tax “refund” is nothing more than an interest-free loan that you gave to the government, which I shared in my article titled “Tax Season Chronicles: Why Your Tax Refund is Your Own Money.” Although your tax refund is essentially your own money, there are many ways to maximize its utility.
Always remember that not receiving a tax refund is the most ideal scenario. It means you paid just the right amount of taxes throughout the year. Most people spend their tax refund money unnecessarily. This is a concept known as impulse spending. Money magically lands into your bank account and you don’t know what to do with it, so you go ahead and spend it. This is the same reason why most people that win the lottery end up broke. They don’t have the financial IQ to manage that money and instead, spend the money unnecessarily. This article is meant to provide you with some knowledge on how to potentially allocate your tax refund.
Your tax refund can either be spent, saved, invested, used to pay down debt, or donated. Some tax refunds are large enough to make a significant impact! Let’s dive a little deeper into the different options.
It’s certainly yours and you can spend it. As previously stated, most people spend their tax refunds unnecessarily. This can leave them with nothing to save and a bad way to start off the new year. Some people even forget about their overdue bills and their credit scores continue to go down the drain. This can be a huge detriment to a person’s financial future. If you have a spending problem, one way is to split your refund into two different buckets: use half of it for something fun (i.e. spend it) and the other half to save or invest it (preferred). The IRS allows you to split your tax refund among multiple accounts, so this can be a pretty good strategy if you’re big spender. Look at it like your 401(k), where money goes into a retirement account that you can’t touch and the rest (or at least some of it) goes into your checking or savings account. At a minimum, you’re putting some money away for the future that can be used to enhance your wealth.
If you know for a fact that you don’t need the money, then you might want to consider saving it. You can choose to beef up your emergency savings, which the rule of thumb is to have at least 3-6 months-worth of your necessary expenses saved at all times. That way, when a rainy day comes, you won’t be stuck outside underwater. Remember that you can have the money directly deposited into your savings account. You can even choose to beef up your retirement savings such as a Roth IRA, etc. When you save for the future, you put yourself in a better position to be prepared for a financial storm or for a great investment opportunity that pops up such as a rental property.
This is my favorite option. Tax time can be the perfect time to get your investments going! If you’re looking to buy an investment property or the hottest investment out there, your tax refund can really go to work. Investing money is where true wealth is built. Be sure to always stay in the know regarding the investments you’re interested in and always do your research. Just make sure you take action after conducting some of that research. Investing a considerable sum of money such as a tax refund can truly pay off. Nowadays, you can buy a home with as little as $0 down!! The refund can serve as part of your reserves and even go towards closing costs. Always remember the concept of compound interest. When you invest today, your money will more than likely grow into something bigger in the future.
Pay Off High Interest Debt
Although I don’t recommend paying off debt before you invest money, I believe that high interest debt can be a huge detriment to your financial future. I’ve seen some credit cards with as high as 30% interest! The more you keep taking out this detrimental type of debt, the more your net worth will be drained. If you have some of these loans, be sure to decide whether paying them off or down would make financial sense, especially, if you’re not a savvy investor.
If you’re generous enough, you may also want to consider donating some or all your tax refund money. Now if you’re just getting started in your career, this probably won’t work out too well for you. There’s nothing wrong with donating money, but if you have an investment opportunity that can generate you cash flow to fund your charity and you need the initial capital for your investment, you should put that money towards the investment. In other words, you need to do what you have to do sometimes to get to where you want to be. Regardless, you should be donating at least something to the causes you truly care about. As we know, there’s more blessing in giving than receiving.
Tax season can generate a pretty massive payday for you. You can either spend it, save it, invest it, pay off high interest debt, or donate it. Ultimately, the decision is yours to make since it’s your money. Just please consider using it wisely. You don’t have to spend any of it. I believe that by either saving or better yet investing it, your future self will thank you forever.
If you have any questions or comments, please don’t hesitate to reach out.