If you overpaid taxes last year, you're getting a refund sometime this spring. That chunk of cash can quickly disappear out of your bank account if you don't have a plan for using it wisely. So, what should you do with your tax refund? Here are the five smartest moves, in order:
- Build an emergency fund. What is an emergency fund? It is a small (or large) chunk of cash that you can get to within a few days. Savings accounts, CDs and money market accounts are all good places to keep your emergency funds. Why do you need an emergency fund? Because you never know what life is going to throw at you. Emergency funds can make things like car repairs, tickets home to see a sick relative, or exploding hot water heaters seem like small problems instead of huge catastrophes. How much of an emergency fund do you need? Well, that depends on you and your life. A single soldier living the barracks is going to need a lot less than a married airman with four kids and a 40 year old house. Try to imagine the worst possible month, financially, then make that your goal for an emergency fund. For me, that would involve a leak in my house, repairs to a car, a dead computer, and dental work that wasn't completely covered by insurance. That's a lot of money. For other people, it might be as simple as money for car repairs or plane tickets. How can I ever save that much money? Start small. Your tax refund can be a great beginning to a healthy emergency fund. Consider setting up an automatic transfer from your checking account to a savings account each month. I find it works better if it is a savings account that I can't easily access, but that is my own personal preference.
- Pay down debt. High interest debt, like credit cards or personal loans, should be paid off first. After that, things like car loans and possibly student loans.
There are so many benefits to this: you'll lower the amount of interest you're paying each month, you'll pay off those debts faster, and you might even free up some money in your current budget. A triple win! - Contribute to your retirement account. There are two ways for military members to do this: either change the amount that you are contributing to your TSP account (using the money from your tax return to make up the difference in your paycheck) or open an IRA. IRAs aren't scary or hard...just head over to your credit union or call USAA.
- Save for future spending. Hoping to buy a really cool car, or put a down payment on a house? Put your money into a safe but interest bearing account. Interest rates are pretty low right now, but for longer-term money, you can get decent rates on some CDs.
- Have a little fun. You may want to take a certain portion of your tax refund for fun. Depending on the amount of your refund, 10% (or 20%) could mean a new Xbox or a new video game. It could mean a trip to the amusement park or a trip to the bowling alley. Designating a certain portion of your return for fun will help make all the other smart choices that much more enjoyable.
With some preplanning, your tax refund can be providing benefits for years into the future. Take a few minutes before your tax refund arrives to plan the smartest choices for your life.
