It’s that time of the year again! Everyone is getting tax refunds and every marketing campaign in the country is trying to convince people to spend their refund on something new. But what is actually the best use of your refund? It’s not what you think!
Don’t Hope For a Refund This Year
I want to start off by saying this: you should not hope for a HUGE tax refund every year.
Tax refunds aren't a good thing. It’s just like going to the grocery store every week and paying an extra $5 for every gallon of milk you buy. At the end of the year, the grocery store sends you a check for the difference between the price you should have paid and what you actually paid. Why didn’t you just pay the correct price every time?
A tax refund is just a reimbursement for your overpayment on your taxes throughout the year. It isn’t new money.
Instead, you should be structuring your taxes and withholdings in such a way that you don’t get a refund or as close to that as possible.
Think about it like this, do you really want the IRS holding on to your extra cash? Of course not. What if you mess up on your taxes and end up not claiming as much as you should? They’re definitely not going to send it back to you. You’re just out the money that you deserve.
What Can I Do With My Refund NOW?
Let’s say that you did get a large refund this year. We don’t want to repeat that in the future, but for now: That’s great! What should you spend the money on?
Every ad on TV and radio right now wants you to spend this extra influx of cash on cars, televisions, phones, furniture. Any and everything!
Some people may plan to do that, but most people I talk to say they plan to apply their refund towards their debt. They use it to pay off credit cards, car loans, and other places they own money. They believe this is the “smart” thing to do with this extra money.
The problem is, most people with debt don’t have any liquid savings. By continuing to apply money towards what they owe instead of building up an emergency savings fund, they’re continuing the feed into the cycle of debt.
Say you use this year’s tax return to pay off a bunch of credit card debt you accrued when you had an emergency but no savings available. You get your debt to a zero dollar balance and continue paying bills as usual. Then, later on in the year, you have another emergency and, again, have no savings to pull from to help pay for it. So you swipe your credit card again and plan to use your tax refund to pay off the debt in a few months.
If you continue on like this, you will never build up a savings account and never get out of debt!
Without 3 months of living expenses in your savings account you should not be making payments towards anything else beyond the minimum requirement. This includes applying money towards your 401k and definitely towards your Credit Card debts.
How Can I Get Out Of My Cycle Of Debt?
Put your money into a liquid savings account and do not touch that account until you have at least 3 months of expenses available.
Next year, you can take any money you have leftover and, knowing that you have an emergency fund, use your refund to pay off your debts.
You wouldn’t build a house without building the foundation first, right? Your financial plan should work the same way. Start your savings first, tackle your debt second, and, lastly, put your money towards retirement and long-term savings. This is the only way you’ll get yourself out of the cycle of debt and start making a future for yourself. If you don’t know how to get started, we can help. We’ll create a plan to get your 3 months saved up before the end of the year so you can start living your best life as quickly as possible.