There seems to be a common theme with the people around me who receive a large income tax refund: the money starts burning a hole in their pocket! When this happens, the money that was supposed to help improve their financial life turns into an inexpensive new car (or an expensive one with monthly payments), a few new outfits, and possibly a vacation.
With a little bit of planning and thought all of this can be avoided.
If you’ve received a sizable tax refund and want to put it to good use, here are ten smart options plus the big reason all of your money shouldn’t go to fun or wants.
Why Spending All of Your Tax Refund on “Fun Stuff” is a Terrible Idea
In psychology there’s a term called hedonic adaptation. This can easily explain why spending all money on fun is a terrible idea.
“The hedonic treadmill, also known as hedonic adaptation, is the observed tendency of humans to quickly return to a relatively stable level of happiness despite major positive or negative events or life changes.”
In a nutshell, this means that spending money on things that are not necessary but that you think will make you happy (like a new car or wardrobe). This will only raise your happiness very temporarily and then you’ll return back to your normal level of happiness – the same as before you bought the items. This is one of the examples of mental accounting we talked about before.
While there is a legitimate argument for spending SOME of your money on fun, you’d be better off dedicating a good portion of your tax refund to bettering your financial situation. This can lower your stress and actually improve your life in a much more sustainable way!
If you don’t know what you should do with your tax refund here and some good options.
1. Get Caught Up on All of Your Bills
Behind on any of your bills? If so now is the time to get them paid up to date.
If you’re behind on a lot of bills start by paying up the necessities like rent/mortgage and utilities. Once you have those under control start working through any other bills that need paid up.
2. Make Necessary and Urgent Repairs (Home/Car)
If you have home or auto repairs that desperately need to be made, these should be a high priority for your spending. Maybe you need a bigger purchase, like brakes or tires? Using your tax refund can make a lot of sense.
3. Buy Items You’re in True Need Of
If you have kids and they’re anything like mine chances are they’re in need of new clothes and shoes at least every six months or whenever a growth spurt decides to hit. If you’re in need of items like clothing or shoes for your kids or yourself, buy now.
4. Start or Increase Your Emergency Fund
If you don’t have an emergency fund this should be number one on your savings list.
An emergency fund is a savings account that has your back when you really need it. As it sounds an emergency fund should be used in true emergencies. It can cover things like an unexpectedly high utility bill, a doctor’s visit, or a broken down car.
Most financial experts recommend having 3-6 months’ worth of income in an emergency fund. But in reality anything is better than nothing. If you don’t have an emergency fund consider putting a portion of your tax refund toward building one. If you do have one increase it if needed.
5. Put it Towards Your Debt
If you have at least $1,000 in an emergency fund and are caught up on all bills consider putting your tax refund toward your debt.
Start with high interest debt like credits cards or payday loans. Work on getting those paid off while still making minimum payments on the rest of your debt. Once you have those high-interest accounts paid in full work down the list.
6. Save for a Bigger Purchase
Another good use for an income tax refund is saving for a large purchase like a down payment on a home or cash for a car.
If you have multiple savings goals you can use an online bank like Capital One 360 which allows you to easily create multiple savings accounts for multiple goals.
7. Put the Money in Your Retirement Account
If you have an IRA but always fail to meet the maximum contributions adding a portion of your tax refund to your account could be a big help.
If you’ve yet to open up a retirement account here’s how to do it.
8. Open Up a College Savings Account for Your Child
I didn’t open up a college savings account for my kids until about a year and a half ago. I wish I would have done this much earlier so the money would have time to grow on its own.
Saving for your kids’ education can be a worthy goal if the rest of your financial life is in order. Even small amounts like $50 per month can add up in the long run.
9. Put a Little Money Towards the Fun Stuff
And last but not least it’s not a bad idea to put a little money toward something fun in your life. Of course, “a little money” is going to mean different things for different people.
If you’re working on major financial goals this could mean treating your family to a $75 dinner. If you have many of your goals met it could mean spending a couple hundred dollars on a weekend out. What matters the most is that you’re intentional with your money and take your own personal situation into consideration.
10. Change Your Withholding And Get Bigger Paychecks
If you're getting a big refund and don't really need or want the money, consider this final option – NOT getting a tax refund next year (or maybe owing money). When you change your payroll withholding, you can get a bigger paycheck each time. This can make a big difference for monthly budgeters. However, when you do this, you likely won't get a tax refund in the future.
So, if you want more money today, and don't want to wait, consider this option.
Remember, if you want long lasting stress-relief put your money toward bettering your financial circumstances.
What plans do you have for your tax refund this year?
Photo Credit: ayo88
The post What Should You Do With Your Tax Refund? (10 Smart Options) appeared first on The College Investor.