It’s tax return time. Many households are receiving tax refunds now or will over the next month or so., but too often, these refunds – which can amount to several thousands of dollars – are spent on consumer goods. Such emotion-based consumer spending typically has no significant impact on the household’s net worth or financial stability. Instead, it tends to perpetuate the mindless spending cycle that keeps too many American households stuck in the rut of paycheck-to-paycheck living.
Here is what we and other financial experts suggest such households ought to consider doing with their refunds instead:
- Set aside 25% of the refund for consumer spending, if the head(s) of the household feels “the urge to splurge.” This may help to satisfy the primal spender within.
- Add 25% of the refund to the household’s emergency fund. This should be held in accounts that are fairly liquid (or easily accessible). A savings account is a standard option, though its rates tend to hover somewhere between the average inflation rate and zero. Other possibilities include Certificates of Deposit that earn a little more interest than savings accounts. Money market accounts are also decent options, as well as interest earning online savings accounts. Rarely will you find an account that offers quick access to your cash but pays interest above the current rate of inflation.
- Use another 25% of the refund to pay down debts. Either send it to the account charging the highest interest rate or to the account with the smallest balance. Where I differ from many financial experts is that I also suggest that you consider paying down your mortgage debt. Even though there currently are tax incentives connected to mortgage debt, debt is still debt. Until a mortgage is paid off, the home owner’s freedom (to move, to rent out the home, etc.) is restricted, just as with any other type of debt.
- Lastly, use the final 25% to add to long-term retirement investments, including 401(k)s, 403(b)s and Individual Retirement Accounts.
Although some of these suggestions might not be relevant to some households, the remaining suggestions probably are.
Please feel free to share your own successes and experiences with your tax refunds.