The other day I was watching TV and a couple of commercials caught my eye. The commercials were basically the same in that they were encouraging people to take their refund and spend it. The only difference between the commercials is that one was pushing cars and the other furniture. Although there’s nothing wrong with buying furniture or a new car, I recommend before rushing out and spending your tax refund that you take a hard look at your finances to make sure there is not a better way to use the money.
It is important to understand that a tax refund is not like a bonus at work. When you get a tax refund, it’s your money coming back to you. What it means is that you paid the government too much during the year and now you’re getting that back. In other words, you gave the government an interest-free loan and now they’re repaying you.
My belief is that there are a few key areas you should consider as better ways to use your tax refund. The first is to pay off debts, particularly high interest rate charge cards. If you carry a balance on a charge card it is basically a slam dunk that you should use your tax refund to pay down your debt. After all, with a typical charge card at 18½ percent, and that interest is not tax deductible, when you pay down debt it is equivalent to getting an 18½ percent return on your money. I can assure you there is no investment that will give you such a high guaranteed rate of return.
Charge card debt is on the top of my list of debts that you should pay off. However, if you are getting a tax refund you should look at your entire debt situation. You may not have charge card debt, but you also can have other types of consumer debt at high interest rates. A great use of your tax refund is to look at paying down on those as well.
If you’re lucky enough not to be in debt, another great use of your tax refund is to make sure you have an adequate emergency fund of money. My general rule is that everyone needs at least three to six months of living expenses for their emergency fund. Unfortunately, most Americans don’t have one. In fact, in a recent report by the Federal Reserve, it was noted that the average American could not financially handle an unexpected $400 bill. Therefore, if you’re in a situation that you don’t have an emergency fund or if your emergency fund is not properly funded, using your tax refund to use for emergency purposes is a great use of that money.
We’ve all heard the stories about how most Americans are in trouble when it comes to saving for their retirement. The numbers are startling as to how many Americans are unprepared for their retirement. Therefore, if you don’t have debt issues and you have fully funded your emergency fund, investing your tax refund for retirement is something that you should consider. Whether it’s in the form of an IRA or not, I can assure you that whatever you put away for your retirement will pay dividends for years and years to come.
Using your tax refund to reward yourself is nice and more likely than not you deserve the reward. However, using your tax refund to improve your financial health is a much better way of rewarding yourself. It may not give you the short-term satisfaction like a new car will, but over the long run, you will be rewarded by making life a lot easier on yourself and improving the quality of your life. Therefore, before you rush out and spend your tax refund, think about using it to improve your overall financial situation.
Rick is a fee-only financial advisor. If you would like Rick to respond to your questions, please email Rick at firstname.lastname@example.org.