First things first; the tax refund is just that – it’s YOUR money being returned BACK to you. It’s not new money. It’s money that ideally you wouldn’t have lent to the government in the first place. Talk to your employer’s accounting department (or whomever handles the tax reporting) about reducing the amount in taxes you pay each paycheck. It’s better to use that money yourself by saving it up in a high-interest savings account throughout the year rather than give the government a free loan.
But for whatever reason, if you’ve overpaid the government and they deem to owe you money, how should you spend it? What should you do with your tax refund?
No matter what the size of your refund, here are a few suggestions. Obviously your own situation is going to determine what you need to do, but here are the obvious things to think about. I’ve grouped them somewhat arbitrarily according to the urgency of the demands each item might place on you, but you can disregard the groupings based on your own needs. “Pay Down Debt,” obviously, is about going beyond the minimum payment – which is clearly a bill that needs to be paid. If you pay off more than that, you’re working to increase your networth. So don’t take this list as a numerical, ordered set of action steps. It’s just a guideline for thinking about your options.
Short-Term: If You Need To Keep Your Financial Boat Afloat
- pay bills – don’t get behind on these, because you’ll ruin your credit score.
- add to your emergency fund – do you have 3-6 months’ worth of salary saved up yet? Many suggest you should be working on this, perhaps even before you pay off all your debt
Medium-Term: Increase Your Operating Cashflow
- start a passive income stream – there are many options for increasing your income. It’s best to diversify your income streams so that if you lose one, you will still have some money coming in somewhere.
- buy dividend stocks – this is a great way to add another income stream. If you set up a schedule of 4-8 dividend payers in your brokerage account, you can receive monthly payouts in cash or let the cash build up as its own emergency fund (my own current strategy) while you work to build your emergency fund proper.
Long-Term: Increase Your Networth
- pay down debt – there may be no sense in investing anything if you’re still paying 15% on some credit card; get rid of all high-interest debt as soon as you can and build a way to stop piling it up
- start or add to savings accounts – open specific savings accounts for your various savings needs: fun fund; vacation fund; car fund, etc. This way you can better control and see how much you should be alloting to each one based on when you will need that money.
- start a DRIP plan – my loyal readers know these are my favourites. I think you can’t get a better investment deal than fee-free DRIPs, ever. These work best for long-term, buy-and-hold strategies. Great for your retirement funds and for first-time investors.
Whatever you choose, keep in mind that this is money that was already yours and so in some sense, should probably go towards playing “catch-up” in an area you’re behind on (unless you need it for some pressing financial emergency, of course).
My personal preference, exempting the need to pay bills if you can’t currently afford that, is to put it towards increasing your operating cashflow. I like dividend stocks that can provide a monthly payout. Let the dividends accumulate in your broker until you have enough saved to buy more stock. Then repeat the process.
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{ 3 comments }
Put it in savings and/or pay off debt! That’s what I would do.
But if you’re doing well financially, and you can consider it extra money, perhaps a vacation is in order…
That’s why I love being self-employed. I never give the gov money during the year. I just pay up at tax time. Although I hate giving them money PERIOD, because they’re stupid with how they spend it, but that’s a whole other rant.
This is actually a great breakdown.
Although I don’t agree with putting investing before paying off debt. I mean even if you wanted to invest, you would need a savings account for that too.
Thats right. that money should grow on your account insted laying down in cautry tresure…
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