Don't Waste Your Tax Refund

Updated: Feb 4

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If you are like most hard-working American’s you might be looking at a tax refund. If you are also like many Americans you may have already spent your tax refund before you got it or even before you knew that you would get one. If this is the case please take a look at some of our other resources to help you get out of debt and onto a budget. on the other hand, there are people getting a tax refund and they are wondering what to do with this money. If you are the latter you are already headed in the right direction by asking the right question.

Before we give you the Money Rant recommendations on what to do with your tax refund I need to first address the idea of the refund and what this could mean for your yearly income. If you are receiving a large tax refund you may be excited but in reality, this is potentially bad news. You may be getting a large refund for reasons you could not control like qualifying for many of the tax credits and write-offs that all Americans should take advantage of if they qualify.

On the other hand, if you did not have many large credits or write-offs and you are still getting a big tax refund this is bad news. What this means is that you are withholding too much money for taxes on your paychecks. Essentially you loaned the government money for months and they are giving it back to you without paying any interest for having kept your money for a period of time. Had that money not gone to the government it would have come to you immediately in your paycheck and you could have used that income to make smart money moves like giving, getting out of debt, saving, and building wealth.

Luckily you can correct this for next year by reevaluating how you filled out your IRS-W9 form. The more you claim on this form the more your employer will withhold for taxes. If you are getting that huge refund you may be withholding too much and need to update your W9 to withhold less. In theory, come tax time we should all shoot to not owe any more taxes nor get a refund. If you can break even on your taxes that is good because you paid your fair share in taxes and the government did not get to keep some of your money that was not due to them.

What’s the sitch?

Now let’s talk tax refund money moves. What you should do with your tax refund is going to depend completely on where you are at overall financially. Do you have an emergency fund? Are you in debt? Did you have or will you soon have a life event that will cost you lots of money? Are you saving to buy a home? Have you started saving for retirement? Depending on how you answer these questions will determine what you should do with your tax refund so I will look at a few situations one at a time.

“I do not have an emergency fund.”

Two words, Murphy's Law. Murphy's Law says that everything that can go wrong will go wrong. One of the worst financial decisions that you can make and one of the easiest ways to go into debt is by not having an emergency fund. As an example the #1 reason that people filed bankruptcy in 2019 in the united states was because of medical expenses. If you do not have any sort of emergency fund we recommend making two money moves with your tax refund:

  1. Give some of the money to a cause that you support

  2. Put the rest of the money into a money market account or a CD for emergencies only

  3. Give yourself a smaller percentage to spend on you

Remember this emergency fund is a rainy day fund. It should sit there until the rainy starts. It is not an “I want a new car fund” so leave it there for real emergencies.

“I am in debt.”

If this is your situation the best thing you can do is to prioritize paying that debt off as fast as possible. We like to say at The Money Rant that debt is a financial hangover. A bad financial decision to take on debt is just like drinking too much, it’s never worth it the next day and it always causes discomfort. The debt cycle in your life needs to stop if you want to have any hope of ever getting into a better financial situation. Debt is dumb. PLEASE be smart. If you are in debt we recommend making three money moves with your tax refund:

  1. Give some of the money to a cause that you support

  2. Use most of the money to pay off as much debt as you can

  3. Give yourself a small percentage of the money to spend on you

Be sure to pay off the loan with the lowest balance. By paying that loan off first you will quickly decrease your monthly debt payments freeing up more funds to go towards your other debts.

“I had (or will have) an expensive life event.”

First off, I am sorry you are going through this. Let's just be honest… isn’t life the worst sometimes? Sometimes I just feel like adulting is hard and I wish I could be a kid again playing at recess with not a worry in the world. I am sure you have that fantasy too. I will tell you what I have to tell myself. "Life is hard, but you can make it through this". Whatever “this” is, you will make it through, I promise. As humans, we were genetically created to learn, grow and thrive. You can thrive again so let's do this! If you are facing an expensive life event we recommend one money move:

1. Use 100% of your tax refund to pay your way out of that life event.

I know that 100% seems unreasonable but when these hard life events happen the best thing you can do is to get through the financial part quickly so that if there are any emotional or physical issues that need to be addressed in the long term they can be addressed, without having to be concerned about the financial impact at the same time.

“I am saving for a house.”

If either of the above three situations applies to you then do not read any further. Get an emergency fund, pay off your debts or get out of the life event. You are not ready to buy a house yet. Now, if you are ready to buy a house and you are starting to save for a down payment, congratulations! Buying a house to live in is a very smart money move and a wise investment. Side note, be sure to put down at least 20% on that new house. Now, if you are saving for a house we recommend making these three money moves:

  1. Give some of the money to a cause that you support

  2. Put most of the money into a money market account or a CD to save for that down payment

  3. Give yourself a small percentage of the money to spend on you

“I have not started saving (or I am under-saving) for retirement.”

If you are to this point you most likely worked very hard to get here so good job! You are killing it already. Now focus in, this part is crucial! When it comes to saving for retirement time is of the essence. Albert Einstein is known for having said “compound interest is the 8th wonder of the world.” But here is the thing, compound interest is not a wonder nor is really anything without time to support it. What I mean here is that the sooner you start investing for retirement the sooner you’re pressing the start button on the compound interest. The longer the interest has to compound the more it compounds. Time literally leads to compound interest. The best way to describe it is with the word exponential. Look it up! So if you already have your emergency fund and you have paid off debt its time to invest in a Roth IRA. If you are at this point we recommend 3 money moves with your tax refund:

  1. Give some of the money to a cause that you support

  2. With the remaining balance put 51% into your Roth IRA

  3. Give yourself the remaining 49% of the money to spend on you

As always drop us a comment below if you have any questions or thoughts to share.

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