4 Questions to Consider Before You Spend Your Tax Refund
Tax Day is coming, and hopefully you expect to get a big return soon after you file your taxes. If you haven’t filed your taxes yet, be sure you don’t miss out; there are five tax deductions that can get you a bigger refund. Once you receive your refund (if you haven’t already), it will be tempting to spend the money on something fun or exciting.
Whether you’re getting $500 back, or you’re getting $2,000 back, there are several things you should consider before you spend your tax refund. It’s easy to spend money, but often when we buy the newest gadget, clothing, or car, the excitement of the purchase wears off quickly. Sometimes it’s a better idea to invest the money, or pay off debt; although it isn’t as fun, doing so can help you achieve future financial goals more quickly. Here are four things to consider before you spend the money.
1. Do you have enough savings?
Much of your financial security will depend on whether you make smart financial decisions. Unfortunately, many smart financial decisions are boring: saving enough money isn’t as exciting as going on a vacation. However, while a trip to Hawaii might be fun now, saving for the future will help you be secure later. You need to save for retirement – ideally, you should start saving in your 20s, and you should consider investing in stocks.
In addition to retirement savings, you may want to save for things you want to purchase in the future (such as a new car or a home down payment). One advantage to saving over time is that it’s easier to avoid impulse buying; if you save for two years and you still want the item, you may feel less buyer’s remorse. If you already have a healthy savings account, you will need to determine if you are on track to purchase what you want, and to be comfortable in retirement.
2. Do you have an emergency fund?
Emergencies are unavoidable, and financially preparing for them will help you avoid using credit cards when emergencies do arise. How much you need depends on your typical income and bills (be sure to include food, clothing, and transportation costs in addition to monthly bills), but most people suggest that you save enough to pay for at least 3 to 6 months worth of expenses. If you don’t have an emergency fund, and you don’t absolutely need to use your refund for anything else, then this might be a good time to start one. It can be dangerous to lump all of your savings together, so be sure to have a separate emergency fund or you risk putting your long-term goals at risk.
If you are starting your emergency fund, it can help to automate your savings; however, using your tax refund can certainly get you on the right track toward having enough money in your emergency fund.
3. What is your current debt level?
If you have so much debt that you can barely afford to pay your other bills, and you worry that you might get evicted from your apartment or home, then using your tax refund to pay down your debt is a clear choice. If you can afford your monthly payments, but you have a significant amount of debt, then the decision can be more difficult. If you are not currently drowning in debt, then you should usually be sure to have adequate savings and an emergency fund before you pay down debt; however, if you have credit card debt or other debt with a high interest rate, you might prefer to pay down your debt in order to avoid interest and be able to put money towards savings every month.
If you are unsure where you stand, first determine if you have too much debt; be sure to consider your credit card debt, student loan debt, auto loans, and mortgage.
4. Who else is involved?
Perhaps you’re a bachelor with no dependents, and you have a great retirement savings and emergency fund with no debt, in which case you might be able to go out and purchase the pool table you’ve been wanting. If you are married or in a committed relationship, you should consider the wants and needs of someone else. If you are saving for a home together, then your tax refund might go a long way toward that goal. If you have children, you can take them into consideration as well. Using your tax refund for fun things can be great, but only if everything else is already taken care of.
Tax season is a hassle, but it can also be a wonderful season if you’re able to pay down debt, save for the future, or even go on a fun trip when everything else is handled.