So you got a big tax refund?! What an awesome feeling! The big question is … What to do with your tax refund?
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 lying out on the beach thinking about unpaid credit card bills! Those Coronas taste sour when they are spiked with guilt.
Here are 7 money-smart ways to spend your tax refund.
Eliminate Your High-Interest Debt
If you have credit card bills that are piling up interest, this year's tax refund 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 around $50,000 of debt in one year. The major reason we were able to do it so fast was by taking advantage of “newfound 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). No matter where you fall on the Debt Snowball vs. Debt Avalanche debate, just make a debt destruction plan and commit to it. This could be a defining moment for you and your family.
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, it can 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 refund and build up your emergency fund. A great savings goal to shoot for is 3 months of living expenses.
If you typically live on $6,000 per month as a family, your goal should be to have $18,000 in a high-yield savings 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!
Invest For Your Retirement
Your tax refund may not seem that large today, but it 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 $4,000 tax refund this year. You take $3,000 of that refund and put it in your Roth IRA in an S&P 500 Index Fund like the Vanguard 500 Index Fund Admiral Shares (VFIAX). If you left that $3,000 alone until you're 65 and contributed the same amount each year, you could have around $450,000 (adjusted for future inflation)!
A vacation would be nice, but knowing you have a cushy retirement nest egg building up makes you feel pretty relaxed as well.
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 refund and pay down your mortgage. More often than not, homes can be our largest expense. By adding periodic principal payments to your mortgage, you can take a huge bite out of it. From experience in making these extra principal payments, the interest savings add up fast!
For 4 years straight, we paid down the mortgage principal on our $400,000 house by adding additional monthly payments and lump sum payments from newfound money like tax refunds. We now live mortgage free on our $500,000 home!
We were thrilled when we became completely debt-free! So much so, we created a mortgage pinata and had our kids destroy it with sticks!
Speaking of kids …
Plan For Generational Wealth
By some estimates, college tuition inflation will increase by 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 refund to start a 529 college savings plan 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.
After 10 years of investing for my daughter, we now have over $50,000 for her future education costs!
Outside of investing for college, you could also invest for your children's future retirement through a custodial Roth IRA (with earned income that is). Or you could invest for their future homeownership with a custodial brokerage account.
If you need help with this process, check out my new course Make My Kid a Millionaire! I provide the 10 steps you need to build and protect generational wealth and happiness for your children.
Get Term Life Insurance
If your spouse and kids depend on your income to live, you need a life insurance policy. When deciding what to do with your tax refund, consider investing in a term life policy to ensure your loved ones are taken care of in case you die unexpectedly.
For most people, I recommend avoiding 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. Get with an insurance provider like Quotacy who can get you quotes from multiple insurance companies.
Start a Business
Have you always dreamed of becoming a successful entrepreneur? Building a 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. When I started my small business, I took advantage of the 5:30-7:30am time slot as it was a special time in the morning for growing my business before the kids woke up and I headed off to my full-time job.
After years of this dedication, I was able to leave my full-time job and work part-time on my business at 40 years old. This has allowed me to dedicate more of my time to my family, health and hobbies.
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.
Final Thoughts on What To Do With Your Tax Refund
Life is short and living for today can be fun. I know I feel a lot more relaxed on vacation when I know my finances are in order. If you feel like you're succeeding in these 7 areas already, then go on that tropical vacation. You deserve it!
If you feel like your tax refund could help propel your family to a better financial future, consider using at least half of your refund for your financial goals. As for the other half, maximize those family experiences and enjoy yourself.
Whatever you decide, know that all of these decisions are easier when you have a plan for your money. Check out our list of the best budget apps for families so you're in control of your money and living the life you've always dreamed of today.
Did this help you decide what to do with your tax refund? What do you think is a smart way to spend the money?
Please let us know in the comments below.