It is getting to that time of year. Where many of us will sit down and plug our way through TurboTax or another do it yourself tax preparation software. By the end most of us will want to pull out our hair, but that refund will often make it all worthwhile. While it may seem like you are receiving a big bonus, this is actually money that you have earned throughout the year; something that you have worked for. That means it is not just “free money” that you can go and blow on whatever you want. Instead, make a plan now so you do use the money appropriately.
Some to Save
Many people claim that they will be saving all of their refund. They know it is important and they know that they should do it. But when that large chunk of money comes rolling it, suddenly it is ok to spend several hundred dollars on themselves rather than put everything in the bank. While spending some on yourself is perfectly fine, without a plan you will almost always end up spending more than you intended. If you have no debt, it would be wise to save (both in an emergency fund and in a retirement account) at least 75% of your tax refund. If you do have debt, shoot for at least 50%.
Some to Pay
There are two schools of thought when it comes to paying off your debt. Some people would like to be debt free no matter what. So even if that debt is at a low interest (3% or less) they want it gone. Others will see that money as working for them considering inflation averages out to 3% over the years. So rather than pay off the debt quickly, they will let it ride keeping their money as long as they can. If you fall into the camp that most people do, that is you want to be debt free, determine what portion of your refund is going to pay down that debt. I would recommend at least 25% to help wipe it out. If you want to capitalize on the time value of money, put the portion you would spend on debt into your savings.
You earned that money, and you deserve to treat yourself to something nice. Now there is no reason to go and spend your entire refund on something frivolous, but you can take a portion of it and have some fun. Personally, my wife and I usually give ourselves a couple hundred dollars each to buy “toys,” and then we use the rest to pay down debt, save, and invest. Obviously on years where our refund is not quite as high, we give ourselves less money. The point is, keep yourself happy now, so you don’t get burnt out on your quest toward financial security.
Wrapping It Up
Too many people see their tax refund as a bunch of money that they can just frivolously blow on whatever they want. If you look closely at those people, you will also see they are the ones most likely to be plagued by overwhelming debt, constantly struggling to make ends meet, and they often complain about how they can never get ahead. Take a few minutes to determine where your refund will go, before you even have your refund. By making a plan, you are more likely to do the responsible thing.
Do you make a plan for your sudden cash influxes?
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