It's just about that time of year again: tax season! If you're like Maria and me, you play it safe and get a tax refund nearly every year. We try hard to minimize the amount of our return (after all, a tax refund is really just the government paying back an interest-free loan you gave them), but it just seems to happen every year and is a lot more fun than having to pay a bunch of money to Uncle Sam. And every year, we face the same question: what do we do with the tax refund? We have a few ideas that you might want to think about when planning what to do with your own tax return. And, as you probably expected if you've read our blog before, you're going to notice a definite “Dave Ramsey” theme running through all of our suggestions.
Pay Down Debt
Got a balance on your credit card? Some student loans yet to go? A few thousand left on your car loan? Getting a tax refund is the perfect time to pay off some debt. Back when Maria and I were dating, I got a bonus at work (I know, it's not a tax refund, but the principle is the same). I looked at the bonus check, then at my car loan and realized they were almost exactly the same amount. Guess what I did? You're darn right, I paid off that car loan. It was wonderful to free up several hundred dollars in my budget a month. And that was even before Maria clued me in to the Baby Steps and Financial Peace University.
Choosing to go debt free was a life-changing decision for us. After the car loan was paid off, we turned our attention to my student loans. I was $180,000 in debt and we threw everything we had to spare – including our tax returns – at that mountain of debt until it was finally paid off. Paying down debt is an awesome thing to do with your tax return. It's not very sexy or fun, but it will help to grant you some serious financial peace of mind.
Maria created this “On Our Way to Debt Free” chart for us. We laminated it and used a permanent marker to color our progress each time we made a payment on my student loans. If you are trying to take control of your debt, visit this blog post to download a free customizable debt-free chart for yourself.
Build Your Emergency Fund
If you've already paid off all your debt, you can move on to Baby Step 3: saving a full emergency fund of 3 to 6 months worth of expenses. Every year when Maria and I get our tax refund, we double check our emergency fund to make sure that we have enough to cover a full 6 months worth of expenses. This was especially important for us last year as we were expecting our new baby and knew that our monthly expenses were going to go up dramatically. In fact, we used almost all of our tax refund to buff up our emergency fund.
Save for Retirement
Already got your 6 months of expenses saved in your emergency fund? Great! Maybe you should consider moving on to Baby Step 4 and saving some or all of your tax refund for retirement. Building up that nest egg for when you retire (even though it seems so far off) is not only smart, but very important. Unfortunately, not enough people are saving money for retirement, and even those that are saving are not saving enough. Maria and I save 15% of our income for retirement and, when we're able to, we plan to save even more.
Save for College
Got kids? Chances are that you want them to go to college. We certainly want Dessa to go to college. (We'll see where she ends up. Maria went to Michigan State University, but I'm a Wolverine. I'm thinking she'll be more like her daddy.) But, college is really expensive, so making sure that you save for your child's college tuition and expenses is important. It's so important that Dave has saving for college as Baby Step 5. We're in the process of getting a 529 Plan set up for Dessa so that her college money can grow tax-free until she's ready to use it. You should take a look at your options, too.
Save for Other Expenses
Dave Ramsey's Baby Steps are designed to get you set for life so you don't have to worry about money. But just because a certain expense is not listed in Dave's Baby Steps doesn't mean that it isn't important. There are all kinds of necessary expenses that you could put your tax refund towards: a car, household appliances (like a washer and dryer), furniture, saving for a child's wedding, gift shopping for the year, the list goes on and on. Plus there are also big ticket items that are just for fun and well-deserved if you save up and can afford to pay cash for them – like vacations, appliances, and electronics.
A few years ago, we put our tax return toward an upcoming anniversary trip to Saugatuck on Lake Michigan. We plan to use this year's tax return as the final installment of our new-to-us car savings, so we will definitely be interested to see how much we get back from Uncle Sam.
Set Aside some “Blow” Money
Dave realizes that most people need some petty cash to just occasionally buy something for the fun of it. It's not meant to be a ton of money, just some spare money you have around so you can let off some steam and buy something you really want. It's not lunch, it's not gas, it's something you wouldn't normally budget for. Like, for me, it would be a video game I've been wanting to play, or a new pair of headphones. It's just fun stuff that you don't necessarily need, but makes your life that much more enjoyable. Because we all need a little spontaneity in our lives.
Donate to Charity
Last, but certainly not least, you can always donate some or all of your tax refund to charity. Maria and I haven't reached this point yet, although we do budget for giving in our monthly budget. But once we've got our forever home paid off, college paid for, and retirement handled, we will definitely be giving much more to charities that are important to us.
Have a Plan for Your Tax Refund
Tax season can be quite annoying (especially if you find out you owe money rather than getting a refund, which we've had happen before), but what you do with your refund should factor in to your overall financial plan. Want to know the best thing I ever paid for with a tax refund? I'll give you a hint: it's round, sparkly, and I'm never the one who gets to use it.
Maria would probably agree that it's my best purchase, too. What's the best thing you ever did with a tax refund?