Reader Question: How to Spend a Tax Refund?
April 18, 2009 by Miranda Marquit
Filed under Finance
With tax season recently over, I’m not terribly surprised that I’ve got a few questions in my email inbox that essentially ask this question:
What should I do with my tax refund?
This is, obviously, a question that you can really only answer for yourself. (Personally, I prefer to have a $0 tax refund) But many people like to have ideas of what they might do with the money to make themselves more financially secure. So, here are some suggestions for using your tax refund money to improve your personal finance situation:
- Emergency fund. If you don’t have an emergency fund, now is a good time to start it. And what better way to start your emergency fund than with what many people consider a “windfall”? Many financial gurus have settled on $1,000 as a good emergency fund start. You can keep adding to it, of course. And if you don’t have $1,000 right now, start what you have and work up to it. Your tax refund can probably get you well on your way to a $1,000 emergency fund.
- High-interest debt. If you already have an emergency fund of $1,000, you should consider paying off your high interest debt. This means credit cards. Mathematically, it makes sense to pay off the debt with the highest interest rate first. Emotionally, you might feel better if you pay off as many of the smaller credit card debts as you can. In any case, using your tax refund to put a serious dent in your credit card debt can be a good idea.
- Invest. If you have paid off your high interest debt, and if you have a good handle on your emergency fund, you might invest your tax refund. Put it to work for you. If you aren’t maxing out your retirement account contributions, put it in your IRA or 401k. If your tax advantaged accounts are maxed out, consider a college savings plan or IRA for your kids. Or invest in an index fund.
- Spend it. Finally, if you have all your other bases covered, you might consider spending your tax refund. There are a number of things you can buy now, before the economy picks up, that represent great deals. Buy some furniture, a computer, increase your down payment amount for a car or pay an extra point on your mortgage. Or just do something fun with it.
We got a tax refund this year, due to our mortgage interest. We’re actually spending it. We’ve got to put in a yard.
What are you doing with your tax refund?
image source: sxc.hu
There is no question in my mind that an emergency fund needs to be established. $1,000 is a good start, yes, but certainly not enough. My opinion of a good emergency fund is 24 months all expenses paid w/ a little wiggle room. For some, that might be a lot of money. For others, not so much money. But, that’s what I like to use. If all else fails, at least 12 months of the ability to have all expenses paid. Especially if you have a family.
Pay off all debt, emergency fund, invest, indulge — In that order :)
Thanks for your thoughts, Aleksandar and Manshu! I agree that $1,000 is little more than a start. Of course, one should keep adding to it. But it is also important to pay off high interest debt as quickly as possible. I like the idea of getting a cushion and then aggressively paying down debt. Of course, if your job is in jeopardy, it’s probably best to shore up the savings first, just in case…
Hi there,
I just wanted to say I think its awesome that you place a high level of importance on having an emergency fund as a crucial tool to financial success.
As a representative from State Farm, we often recommend that our policy holders integrate insurance considerations into their overall budget plan and emergency fund planning, especially now more than ever as the economy continues to fluctuate.
As people think about how to establish their emergency fund, we at State Farm urge our customers to incorporate the cost of potential insurance deductibles – auto, home, health, and others – in the event of a claim – into their plans and emergency funds, as you never know when the unexpected will arise.
Does anyone else have any other helpful tools people can use when trying to chart their finances as a means to reaching a specific financial goal?
I think you make a great point about including deductibles into the emergency fund. It is important to have that money available when you need it.