Perhaps you loaned Uncle Sam interest free this past year and now you’re expecting to get an income tax refund. A lot of people, including financial professionals and personal finance bloggers, may tell you it’s not wise to receive a refund.
Well, I’ll tell you they’re probably right in most cases. Just remember that you’re loaning your money to the government interest free. In other words, you’re investing with a 0% return. But don’t be discouraged if that was your situation this past year!
The important thing to do now is to establish a good plan for managing your tax refund. Look at this as an opportunity to manage the refund money wisely and make headway towards some important financial goals.
I don’t want you to look and up realize your tax refund is gone within a week, and without a plan, it just might happen. It would be foolish to take the money and spend it all, so it’s critical you avoid buying on impulse and letting it dwindle away!
Perhaps you’ve heard of the 80-10-10 approach to managing money. 80% is typically used for living expenses and spending, 10% is used for giving and the other 10% is used for saving. Consider a similar approach for your income tax refund (with some modifications).
1. Get out of Debt; 2; Save Some; 3. Spend Some; 4. Give Some
Basically, this approach allows you to use a portion to get out of debt (if you’re in debt), save some money towards emergencies, enjoy some free spending (or purchase things you need) and give some. The idea is to use your tax refund money across all of these areas.
A note on giving: The approach assumes you’ve tithed or given throughout the year based on your gross or pretax income. If so, you don’t need to tithe on this money again. If you haven’t done so, I recommend you make giving your top priority.
1. Get out of Debt
It’s certainly your decision, but if more than 5% of your take home pay (not including the mortgage) is debt, I would lean towards putting 70-80% of the refund towards this particular goal.
Depending on the size of your refund you might be able to pay off one of your smallest debts completely! You might even have an opportunity to become debt free if you don’t have much debt to tackle.
2. Save Some
Make sure you’re saving some money. Use 10% as a guide here. However, if you don’t have at least $1000 in your emergency fund, you should seriously consider funding this initial savings before paying off any debt.
What are some savings ideas? Beyond funding your emergency savings, one of the biggest expenses every year for families is Christmas. This is a great opportunity to begin saving towards this goal (or funding it). Or, perhaps you need a vacation or to save to replace some necessary items such as tires on the car or home repairs? Why not contribute savings for these areas to a freedom savings account?
3. Spend some
Consider using another 10% for spending money. Yes, it’s okay to have some blow money, or fun money to take to the mall. And by blow money, I mean its actually okay to use it on some impulsive purchases as long as you stay within the amount allocated for that purpose.
What are some spending ideas? This area typically includes the things you want. You could buy a new book, get a new computer, or if you’re a blogger, you could purchase a new theme for your website! Obviously, it all depends on the size of the tax refund, but have some fun here.
4. Give some
Finally, you may be led to give more than you already have this year. Depending on your thoughts and feelings here, this could shift all of your allocation decisions across each area. If you’re a Christian, consider where you should give. I think a good approach is to give first to our local church and to those who are directly responsible for ministering and teaching us. Then, you might choose to contribute to a Christian ministry to further kingdom work.
Final thoughts
I think the most important thoughts I can leave you with is where we started. Don’t let your tax refund go to waste and make sure you don’t spend it before you’ve receive it! You may be getting a tax refund this year, but use it as an opportunity to accomplish some important financial goals and to also allow yourself some fun. But keep in mind, a tax refund shouldn’t be a free pass to go do whatever you want (blow it) with the money. Remember, it’s still our responsibility to manage it wisely.
Photo by CBCastro
{ 7 comments… read them below or add one }
My husband and I received a very small tax refund this year and we both agreed to use it to pay off the last of one of his school loans. Since being debt free is a priority for me I think we made the right choice. The little we had left from our refund went into our emergency fund. I know firsthand the importance of having some “just in case” funds.
Thanks for the article,
S
Shirley, it sounds like you managed your refund very well. An important point to make is you and your husband talked about how to manage the money. Great job!
My wife and I have discussed two different options. She has been wanting a new couch for some time now, and after much searching one has been found that we both like. We also like the idea of putting a small dent in our (still growing) college debt as well.
I am all for applying our return to the debt, and my wife is certainly supportive. However, she certainly enjoys the idea of having a new couch (ours is pretty worn).
So, we haven’t decided what to do with our return. While it will be gone in one fell swoop, it will not be without a plan.
I’m sorry but I think giving to the church is the least charitable way to give. The money goes back to you in terms of getting your free coffee with your sermon, your organized picnics, any activities, your new pew seats etc. Why not give to people who really need it instead of indirectly spending on yourself and patting yourself on the back for it.
Excellent post and a very good set of recommendations. I particularly agree with making the $1000 emergency fund top priority, followed by using the majority of the refund to get out of debt. One small addition: if you’re refund is anything around $1200 (i.e. $100 per month too much paid in), talk to your HR department and adjust your withholdings so you see that $100 more per month in your paycheck instead of (as you so wisely put it) loaning it to Uncle Sam interest free.
Great post, what really important is you know how to handle your finances and discuss your financial activities and status with your family.
Good points. Spending the biggest part on debt reduction makes sense. Emergency fund is a must if someone doesn’t have one.