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Editor's note: A version of this article originally ran on the blog Debt-Free Mormon. It has been reprinted here with permission.
It's coming up on tax deadline time. So if you haven't done your taxes yet, get on it. Not filing is not something to mess around with.
If you have filed your taxes and are getting a refund, what are you going to do with it? What should you do with it? I'm definitely not a tax guy, so if you have questions about taxes, talk to your tax expert.
But I will say this about refunds ... I typically don't like them.
If you're getting a refund, you're most likely withholding too much from each paycheck. You should adjust your W-4 so at the end of the year you don't owe any taxes, but don't get a refund either.
A refund isn't a gift from the government. You overpaid and the government is sending it back to you. I don't like refunds for these reasons:
1) Many of you could use that extra money each month to help pay bills, pay down debt or just apply to whatever you are working on: an extra $200 a month could make a real difference in many cases.
2) The government holds the money you overpay interest-free; you could find a better use for that extra money.
Yes, I know what everyone says: "I like getting a big refund, because otherwise I'd just blow the extra money I get each paycheck," or something like that.
Guess what? If that's your attitude, you're likely going to blow your refund, too. You have to be smart with every dollar you make. You work too hard not to be.
If you have a budget and are on a plan, then any extra money you get should be used efficiently, whether it's with each paycheck or a refund at the beginning of the year. Talk to a financial adviser for help if necessary.
But for now, if you do have a refund, how you use it should use it will probably vary depending on where you are in your personal financial life. Here are four ideas:
1. Pay down debt.
According to bankrate.com, paying down debt is the most common thing people intend to do with their tax refund. This is great news. If you do this, congratulations!
But even then, be intentional. Make a plan for which debts you will pay off or pay down, how much you will pay, etc. Do it on purpose.
I subscribe to the snowball theory of paying down debt. If you are following the plan I talk about and follow myself — one suggested in The Church of Jesus Christ of Latter-day Saints' guide One for the Money and made famous by Dave Ramsey — it's best pay off the debt with the lowest balance first.
Don't just dump a little money here, a little money there — that isn't efficient. Follow a specific debt pay-down plan and be intentional. Apply the extra money from your refund to your current monthly income and budget and follow your plan. Don't do anything too drastic or too different.
2. Create an emergency fund.
If you don't have an emergency fund in place, that might be a great place to start. The emergency fund is a critical part of your financial plan.
If you have debt, it can be difficult to find the extra cash to set aside for emergencies, so your tax refund is perfect for doing this.
So how much should you put in that fund?
Like everything else, this depends on where you stand in your financial plan. If you have a bunch of debt — aside from a mortgage — and you are now trying to get on a plan to pay it off, then you need a starter emergency fund. It should be at least $1,000, not much more. You want to be putting as much money toward your debts as possible. The more you put toward the debt, the faster you will pay it off — logically.
If you don't have any debt, make sure your emergency fund is about six months of your total household expenses. If you don't have this much saved, use your refund to get it closer to that number.
3. Save or invest.
If you are out of debt — not including a mortgage — you can use your refund to fund some retirement accounts or your children's education or other funds (like an LDS mission).
Depending on the investment type, you could max out your contributions for the year using your tax refund and not have to worry about contributing the rest of the year.
I'm not an investment guy, either, so talk to your financial adviser or planner and find out what your particular contribution limits are and if you can use your refund to max those out.
4. Add to savings goals or fund a budget category.
If you are in the process of saving money for a specific big purchase, use your refund to either add to the savings fund or reach your savings goal. Maybe you are saving to buy a new couch that you've needed for a while or to put a new roof on the house. Your refund could be a good opportunity to speed up that process.
You could also use the tax windfall to fund a category in the budget that requires a monthly contribution, such as car-repair expenses.
There are some expenses you can't predict when it comes to your cars. But some you can anticipate: oil, tires, brakes, registration, inspections and regular maintenance. If you figure out the total estimated costs of these expenses for the year and divide that number by 12, you can get an idea of how much to budget each month.
You could use your refund to fund this category for the entire year; then you wouldn't have to set aside the money monthly in your budget. It could also help you avoid having to use your emergency fund if something were to go wrong with a vehicle, in this case. Try it with any similar expense category.
Only do these types of additional savings if you are out of debt and have a fully funded emergency fund.
5. Pay down the mortgage, go on vacation, give.
If your only debt is a home mortgage, you have an emergency fund, you've maxed out your investment contributions, and you don't have any specific big savings goals you are trying to meet, then do something rewarding. Take the family somewhere fun, pay extra on the mortgage or make a philanthropic contribution.
Obviously, be smart about what you do with any extra money you have. But if you're in this position, you probably have been pretty smart for a while now — I should probably be listening to your financial advice.
The key to being smart with your tax refund or any extra income you come across is to make sure you are being intentional about it; do things with a purpose. Don't just let cash come in one hand and flow out the other. Have a plan: Take care of the needs of your house and your family first. Use the budget to tell your money what it should do, and tell your refund what to do.
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