Discovering that you’ll be getting a tax refund is certainly not the worst news you’ve had in your life. In fact, it’seasy to see a tax refund as some kind of gift from the universe. You might even be feeling kinda’ proud of your forced saving accountto which you knowingly contribute every payday while living from paycheck to paycheck and relying on credit to make ends meet.
But here’s the truth: A tax refund isn’t a gift—it’s part of every paycheck you should have been getting all along. It’s not a saver’s reward. You overpaid your taxes. Plan now for how you’ll manage that check or your tax refund could evaporate into thin air.
Get smart
Change your withholding (use this calculator to determine the amount you should be having withheld along with instructions on how to change it). Your goal is to neither owe nor to be owed at the end of the year. A big tax refund is not a good thing! If you can come within $100 of that goal, you’re golden.
But wait, you’re not done. Lock eyeballs with the additional amount you see in your next paycheck—the amount you will not be sending to the IRS to hold onto for you. Do what good money managers do: Create an automatic deposit authorization at your bank or credit union to transfer that amount into your savings account. Out of sight, out of mind.If you leave it in your checking account I promise it will simply evaporate in your routine spending. Now is your opportunity to act responsibly.
As for this tax refund, you have options—at least five that follow.The decision you make about what to do with that check could either make things worse or it could make your life so much better. Choose well.
1. Create an emergency fund
It’s easy. Take the check to your bank or credit union, and use it to open a savings account. Then walk away and leave it alone, knowing that you have a fallback if something serious and unexpected happens that you absolutely cannot cover with your regular income.
You might lose your job and need to keep food on the table and the bills paid for a few weeks while you make the transition. You may lose a friend or relative five states away and the trip is more than you can handle without going int0 debt.
How it makes your life better
Having an emergency fund eases the stress in our lives. Just knowing that you have a way out of unexpected, totally unforeseen money jams in the future, eliminates worry. You’ll back away from worry and anxiety for what you will ever do if your car doesn’t start or if you lose your job. That’s the side benefit of having a contingency fund in place.
- MORE: How to Get $1,000 Into Your Emergency Fund
2. Pay off a debt
If your emergency fund is established, consider using that refund to pay off a debt like the balance on a credit card account or student loan bill. Just do it before you think of a dozen ways to fritter away that refund money.
How it makes your life better
It’s hard to describe in words the wonderful feeling of freedom that comes with knowing that debt is gone. No more payments on it, no more lingering, annoying balance to deal with every month. You’re free from it. Whatever the monthly was on that debt is yours to keep and manage in a way that will improve your life. It will be easier to keep all of your other bills paid.
3. Open an IRA
Using the refund to improve an existing retirement account or start a new one could be the smartest thing you can do with that refund. Once you’ve done that, it will sit there and earn a solid return each and every year, with the balance compounding and growing, until you reach retirement age.
How it makes your life better
If you opt for a Roth IRA, using the amount of this tax refund to open it, plus the compounding growth over the years until you choose to withdraw during retirement, is all yours. All of it! That’s the nature of a Roth IRA. See your tax advisor for more specific information that relates to your situation. To open that account, see your bank.
- MORE:The Ultimate Risk-Free, High-Yield, Guaranteed Investment
4. Anticipate what’s coming
How emergency-prepared are you with a supply of non-perishable food and water? Do you have a solar generator in the event of a power outage? Or are you ready to replace a major item like a car or some other big item whose imminent demise is looming large?
Use this tax refund to get ready for it. Putting money aside in anticipation of a specific need is really smart. That’s what money managers do. They see the big picture and plan accordingly.
How it makes your life better
By having at least some amount of the cost of what you know is coming down the pike, you will eliminate stress and worry about how you will ever be able to deal with it. You stop living in denial because now you have a plan and money in the bank to deal with it.
- MORE:Dumb Things To Do with a Tax Refund
5. Invest in your future
Rich people start out as poor people. If this tax refund is money you will not need for at least 10 years, put it to work in the stock market. Take the plunge, trust your decision, and then don’t look back.
How it makes your life better
Because you are investing for the long haul—not jumping in and out of the market, you can rest and relax knowing that you are making your financial future better, no matter what happens. You will be in better shape than you would have been had you spent that tax refund check wastefully. That means less money stress and fewer worries to keep you up at night.
Don’t know how to get started? I commend to you Mike Piper CPA, author, and investor. First, read his book, Investing Made Simple. It’s simple, easy to understand, and fewer than 100 pages for those of us with the attention span of a gnat.
This book is the best thing out there if you feel like you know nothing about investing, have no clue how to get started, and are scared to try. Read it, small cover to cover (this book is like pocket-size!) then become a devoted follower of his blog, Oblivious Investor. Learn all you can about Index Funds. Ask questions, build confidence.
I’ve known Mike for years, follow him closely, and trust his teaching and sound advice. You should, too.
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