So you got a big tax refund?! Sweet! What an awesome feeling!
The big question is … What should you do with this unexpected money now at your disposal?
The first reaction for those of us who work long hours and are sick of the winter weather is to plan a tropical vacation. We're all thinking sunshine, umbrella drinks and white sandy beaches.
Now, I'm all about the tropical vacation, but it's important to consider some other options that will improve your financial situation first. You don't want to be laying out on the beach thinking about unpaid credit card bills! Those Coronas taste sour when their spiked with guilt.
Here are 7 money-smart ways to spend your tax refund:
1. Crush Debt
If you have credit card bills that are piling up interest, student loans that have been around way too long or a home equity line of credit that you've been using like an ATM, this year's tax return can help stop the bleeding.
Whether you're getting $50 back or $5,000, take this moment to begin eliminating debt from your life. My wife and I paid off $48,132 of student loans and car debts in one year. The major reason we were able to do it so fast was by taking advantage of “found money moments” like getting money back on our taxes.
If you don't have enough to completely pay off one of your debts, that's okay. At least get the process started and begin paying down your smallest debt (Debt Snowball) or the one with the largest interest rate (Debt Avalanche). Make a debt destruction plan and commit to it. This could be a defining moment for you and your family.
2. Create an Emergency Fund
When “the unexpected” occurs like car trouble, home repairs or job loss, it feels like those emergencies come out of nowhere. To resolve one of these major life issues, we feel like we're forced to go further into debt if we don't have the proper savings in place.
To avoid this situation in the future, take your tax return and build up your emergency fund. A great savings goal to shoot for is 3 months of living expenses. If you typically live on $3,000 per month, your goal should be to have $9,000 in a savings or money market account. This way you're covered for a decent amount of time if you lose your job. You'll also have plenty of cash left over if the furnace goes out or your alternator breaks in your car. Once your savings has been built up, these emergencies don't feel like emergencies anymore!
3. Invest for your Retirement
Your tax return may not seem that large today, but it definitely has the potential to become massive through the cosmic wizardry powers of compound interest.
Let's say you're 30 years old and you get a $2,000 tax return this year. Instead of vacationing, you take the $2,000 and put it in your Roth IRA in an S&P 500 Index Fund like the Vanguard 500 Index Fund Investor Shares (VFINX). If you left that $2,000 alone until you're 60 and contributed the same amount each year, you'd have $474,657.70!!
That vacation would be nice, but a cushy retirement nest egg also makes you feel pretty relaxed as well.
4. Pay Down Your Mortgage
If you've eliminated your debt, have an emergency fund in place and you're saving for your retirement, consider taking that extra tax return and paying down your mortgage. More often than not, homes can be our largest expense. By adding an additional principal payment to your mortgage, you can take a huge bite out of it. From experience in making these extra principal payments, the interest savings adds up really fast!
For the last three years, we have been paying down the mortgage principal on our $400,000 house. By December 2017, the house will be paid off. We're thrilled for the moment when we become completely debt free including the house!
5. Save For Your Kid's College Fund
According to FinAid.org, college tuition rises on an average of 8% per year. INSANITY! That means, if you want your kids to attend college and not go into massive student loan debt, you're going to want to start investing early.
Use your tax return to start a 529 for your children. The same principle of compound interest works here as well. The earlier you invest, the more your account can grow. Get started, contribute to the account consistently and your kids will get a jumpstart on life because of your money-smart moves.
6. Get a Life Insurance Policy
If your spouse and kids depend on your income to live, you need a life insurance policy. With this new-found money from your tax return, invest in a term life policy to ensure your loved ones are taken care of in case you die unexpectedly.
Avoid whole or permanent life insurance policies as you are better off investing those high monthly payments in the stock market. Term life can give you the best coverage and the lowest monthly payments. I’d recommend getting with an insurance provider like Quotacy who can get you quotes from multiple insurance companies.
7. Start a Business
Have you always dreamed of becoming a successful entrepreneur? Building your business takes time, patience and a little bit of dough. The money you just got back on your taxes can be the capital you need to make your new business dreams come true.
Find some extra hours in your week to work on your business plan. Think about what your product or service could be, how it will fill a need in the marketplace and what it takes to make the business a reality. Personally, I take advantage of the 5:30-7:30am time slot for my blog and podcast adventures. It's my special time in the morning for growing my business before the kids wake up and I head off to my full-time J.O.B.
Once you get in the groove and your business begins to make money, the extra income you'll be earning will help you expand your business and enjoy more of the luxuries life has to offer.
Yes, I know life is short and living for today can be fun. I'm speaking for myself when I say that I feel a lot more relaxed on vacation when I know my finances are in order. If you feel like you're killing it in these 7 areas already, then go on that tropical vacation. You deserve it!
What are you going to do with your tax refund this year?