Ah, tax season. For some of us, it’s a mad scramble to gather up receipts, 1099s, W-2s, and all of that mail that has “Important tax documents enclosed” stamped across the front while frantically emailing our tax professional about deadlines. Others already have all of that stuff organized, and are probably busy trying not to gloat about their magical (and inspiring) tax preparation powers. Regardless, there are people in both camps who are wondering what to do with a tax refund.
While it always feels good to get a little something back from Uncle Sam, getting too much back is a tell-tale sign that it may be time to adjust your withholdings for future tax years. However, if you’re looking forward to a refund this year, let’s talk about what to do (or what not to do) once that deposit hits your checking account.
What to Do with a Tax Refund
A tax refund can feel like “found” money, and it’s tempting to treat it as a windfall. And that’s fair—after all, a vacation, wardrobe update, or new gaming system is more fun than “more responsible” options, but think about what you really want before you indulge in a spending spree. Short-term fun is great, but achieving a financial goal can lead to long-term peace or enjoyment. Here are four ways to get the most out of your tax refund:
1. Pay Down Debt
Let’s be real—paying for stuff you’ve already bought doesn’t provide the same little rush of endorphins that buying new stuff does. It may be good advice from a personal finance perspective, but I’m not about to try to sit here and convince you that sending in a credit card payment beats the unboxing high that comes with a new purchase.
But hear me out: debt weighs you down. What opportunities could you pursue if you were debt-free? No monthly payments of any kind?
Could you travel more? Quit your boring job to do work that excites you? Start a small business? Sleep better at night without the stress of impending emergencies and expenses?
Debt costs more than just the interest accrued—there’s opportunity cost, as well. If you’re wondering what to do with a tax refund, consider the true costs of your debt. Choose the credit card or loan with the highest interest rate and send your refund in that direction to buy yourself some breathing room.
Experiment with YNAB’s Loan Planner tool to see exactly how much that extra payment will save you in terms of time and money.
2. Start an Emergency Fund
According to a Bankrate survey, 56 percent of Americans couldn’t cover a $1,000 emergency expense with savings. Maybe this is my own bad luck talking, but the likelihood of a $1,000 emergency seems pretty high.
By definition, emergencies are pretty stressful. Add not being able to pay for one, and you’ve got a potential avalanche of anxiety.
Use your tax refund to protect yourself against life’s uncertainties. Stick that money in a savings account, create a budget category called “Emergency Fund” and allocate that number of dollars to it, or fund some of your true expenses—the expected, but infrequent enough to be surprising, expenses that pop up along the way.
3. Get Ahead of Your Paycheck
Some folks call it a cushion, others call it a buffer, and at YNAB, we call it Age Your Money. The point is that you have more money in the bank than you need, and it’s a very low-stress way to live—two thumbs up, highly recommended by anyone, ever.
It plays out like this: get a bill, pay it with money you earned last month (or the months before that). Get a paycheck, and put it in the bank for safekeeping until at least next month. The theme is that you don’t need the money that comes in today. If that sounds like an impossible dream, remember that you just got a tax refund, and then read these 10 ways to get a month ahead of your expenses.
4. Invest in Your Future
Finally, if you’re debt-free and cash is no concern, it might be a good time to start investing! Giving your dollars the job of recruiting more dollars can help you ramp up your wealth over time, giving you the freedom of choice—whether it’s quitting your job, paying for your child’s college tuition or upgrading to the house you’ve always wanted. Why not start with your tax refund?
If you’re new to investing, check out Invest Like a Pro for Jesse’s advice on how to get started.
The Decision Is Yours
While it might be tempting to buy the fancy area rug that you’ve had your eye on (it would really tie the room together, right?) or take off for an impromptu weekend trip, consider the power of your choice … and use that tax refund money to support the things that will generate the most (true) happiness for you!
Ready to gain total control of your finances by putting your tax refund to work? Start a budget! Try YNAB for free for 34 days.