Happy Tax Day! Have you finished your taxes today? If you have (or even if you haven’t), make sure you take advantage of all those tax day freebies out there! At least you can get something free today which, depending on how tax season went this year, could be a nice way to end the tax season this year.
If you are getting a tax refund back this year, have you thought about how you’re going to use it? Before you get carried away with dreams of going on an exotic vacation, consider the following when deciding how to use your tax refund.
Establish Or Add to Your Emergency Fund
If you haven’t started an emergency fund yet, stop what you’re doing and immediately put your refund into this fund! Emergencies, like a car repair or job loss, can strike without warning. By having an emergency fund, you’ll be able to take care of the emergency and have one less thing (money) to worry about. After all, if you’re dealing with an expensive car repair, the last thing you want to worry about is how much this is going to set you back.
Already have an emergency fund set up? First, high five! Second, do you have enough to see you through a big emergency, like an expensive medical bill not covered by insurance? Many personal finance writers recommend you have 3 to 6 months of net pay saved up in case of a big emergency, like losing your job and being unemployed for a few months.
As much as you may prefer to use your tax refund on something more glamorous than adding to your emergency fund, just keep in mind you likely didn’t count on or expect a tax refund. Consider it a bonus and, if your emergency fund could use a boost, give yourself peace of mind by saving your refund for a future emergency.
Increase Your Retirement Savings
Another way to use your tax refund responsibly is increasing the amount you’re saving for retirement. Use your tax refund to max out your 401(k) or, if one isn’t offered by your employer, increase your Roth IRA or Traditional IRA contributions. Using your tax refund to max out your 401(k) is a great way to easily save for your retirement, reduce your taxable income and take advantage of your organization’s perks.
If your organization doesn’t offer a 401(k) option, you can use your tax refund to open or increase your contributions to a Traditional Individual Retirement Account (IRA) or Roth IRA. You can contribute up to $5,500 in 2015, and depending on the amount of your refund, you may be able to make a significant impact to your retirement account this year. Also, a Traditional IRA will reduce your taxable income immediately, conferring tax benefits next year.
It’s never too early to plan for retirement, and investing your tax refund into retirement accounts is an excellent way to get ahead on saving in 2015. If you have met your emergency fund goals, using your tax refund for retirement savings is a great way to take care of your future self.
Between saving for your emergency fund and paying down your debts, I’m more in favor of saving up for emergencies. That’s partially because I had two emergencies happen to me last year, which decimated my emergency fund. However, it could have been worse if I didn’t have enough in savings. With an emergency fund, you can at least use it to pay some of your debt if you lose your job versus adding more to your credit cards just to pay the bills.
That said, depending on your debt burden, you may want to use your tax refund to address debt repayment. If you have credit card debt, it’s imperative you pay this off as quickly as possible. If you have multiple lines of credit card debt, you can choose to pay off the one with the highest interest rate or the one with the smallest debt.
After credit card debt, take a look at other debt you may have accumulated, including your auto loan or student loan debt. Recommending how to pay down these debts is more based on your situation than one particular “rule”. If you are close to paying off your car and want to erase that debt forever, consider paying off your auto loan now. Not only will you have paid off that debt, but you’ll free up money that you were paying monthly to put toward other debts to wipe them out faster.
Splurge on Your Vacation
After giving you three ways to spend your tax refund responsibly, I couldn’t end this post without making a mention of splurging. I don’t mean spending your tax refund on a first class flight to the Bahamas for an all-inclusive resort stay for you and 4 of your closest friends. If your refund was that big, you may be doing your taxes wrong.
When I say “splurge”, I mean allow yourself to indulge in a little on a vacation. If you’re already planning a summer trip, use your tax refund to help pay for your hotel (or AirBnB), rental car expenses, or a few nice meals out. You can still be frugal by charging your expenses to your rewards credit card to maximize your points, but then use your tax refund to pay off that bill before your trip.
Vacations with family or friends create memories you’ll remember for a lifetime, and life is too short not to indulge every once in a while. If spending your entire tax refund on your vacation seems wasteful, go ahead and put some of your refund toward your emergency fund and your vacation, or pay down some debt and pay for a camping trip with your family. Being responsible with your tax refund can be a balancing act, but allow yourself to have a little fun every once in a while!
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How do you plan on using your tax refund this year? If you owed money, join the club! I owed this year too, but my fiance received a refund. He’ll be paying for (part) of our vacation this year.