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It's Christmas in March! With millions of Americans waiting for Santa (otherwise known as the IRS) to deliver their tax refunds, it begs the question...what is the right thing to do with the money? It is a good question, and one that actually deserves some serious thought.
First, we must dispel an important piece of "fake news". Your tax return is not found money. It is not a gift from Uncle Sam. It is not a bonus from your employer. It is not "extra". It is your money—which you generously loaned to the federal and/or state government at a zero percent interest rate during 2017. I am not trying to rain on the refund parade, nor put a lump of coal in the proverbial stocking, but understanding what this money really is will help you make a good decision about what to do with it. Some think of it as forced savings (which is true if you actually save it when you receive it) but in reality, it just means that you overpaid.
So, what should you do with it? That really depends on how well your other financial priorities are in order. For example, if you do not have six to twelve months of monthly expenses available to you in your savings account, then you can stop reading at the end of this paragraph. Put the money in your savings account and keep it for a rainy day. It is important that your last line of defense is well intact before you start looking at other options. If you don't think this is important, you are fooling yourself. Ask anyone who has unexpectedly found themselves out of a job, battling an illness, or with unexpected housing-related expenses. You need it. Consider it your financial multi-vitamin.
Assuming that duck is in its row, let's move on. The next thing I would do is pay off any outstanding credit card debt you might have. The average credit card has a 15% interest rate attached. If you pay minimum payments throughout the year, this is finally your chance to make a serious dent. Remember, if you make minimum or almost-minimum payments then you will end up paying almost as much in interest as you paid for the item you purchased to begin with. And what happens the next time you need to use your card is the balance gets even higher, and so does that minimum payment. This is your chance to eliminate some or all of that interest you pay during the year. And it is the gift that keeps on giving—let's say you pay off a credit card on which you have been making $100 monthly payments during the year. Now, not only have you gotten rid of your debt, but you've also saved $1,200 that can be used for other things.
Another good idea for those extra funds is to finally take care of those nagging items that protect your family from the unexpected. If you have been putting off creating a last will and testament or purchasing life and/or disability insurance, now is a great time to check those items off the to-do list. All three of these critically important items are very easy to kick down the road. None of them is particularly fun to think about, and none brings you immediate gratification (though I will admit that having my will done did help me sleep better at night). But they are critically important to your life. Don't believe me? Then spend some of your tax refund taking a friend or family member out to dinner who has had the unthinkable happen to them or someone they love. Ask them about how important these protections are.
While we are taking about things you should have in place, let's face it…you didn't save enough for retirement this year. I am not talking to those who maxed out their 401(k) or made their max IRA contributions…I am talking to the rest of you. The bottom line is that if you are not saving 10% of your gross income for retirement, then you are not doing everything you need to do in order to live the future you want to live. Even if you can't do the full 10%, you should be extending yourself to do more. It can be a ROTH IRA or a traditional IRA. You can even just use this as an opportunity to increase your 401(k) or 403(b) deferral at work. With time as your biggest asset in retirement planning, every extra dollar you put in today is many fewer dollars you will need to put in later.
Last, but not least, get ready for summer. No, I am not talking about tanning beds or buying new bathing suits. I mean, prepay for all of those things you already know you are doing this summer but haven't quite figured out how to pay for. Maybe you have a vacation planned. Or a wedding or two for which you need to buy gifts or something to wear. Maybe your child's summer camp payment is due. Whatever it is, end the trap of spending it now and figuring it out later. If you know you have future expenses, pay for them now. You will be happy later.
Many of you may be sitting there saying, "I would like to pay off some debt, or buy life insurance, or pay for my trip to Maui, but I need this money just to live." If this is you, then you need to use your tax refund to buy yourself a bottle of wine, sit down, look yourself in the mirror and recognize that you are living above your means. If you are counting on money that you don't have and can't count on just to cover basic expenses, then you have to use this opportunity to make some changes so that next year, the first six paragraphs of this article apply to you too.
Look, I know that there are things other than what I mentioned above that you would much rather spend your tax refund on. I get it—but let's face facts. Most of us are salaried employees who know exactly how much money they will bring in during the year. That can make it difficult to find the funds to take care of any of these things. This is a unique opportunity. So, whether you take this advice or just file it away, keep it in mind for future years. You will not regret it.