Last week we discussed why you never want to have a tax refund, which is an interest free loan to the government. But the best laid plans often get off track and you may still end up with a large tax refund. If you do, take this opportunity to do something great in your life with your windfall. Don’t blow this chance by spending the money frivolously. Use the opportunity to advance your financial position.
Large, unexpected lumps of money don’t come around very often. I remember a tenant of mine who got an inheritance from his grandmother. She saved her entire life for that money. It was a sum equal to a year and a half of his income. He spent the entire inheritance in less than 30 days. Some of his purchases increased his monthly expenses, and he was barely getting by already. He was unable to pay his rent the next month and ended up getting evicted. What a blown opportunity from a lifetime of savings! I’m sure his grandmother was turning over in her grave from this one.
I don’t want you to blow your opportunity to turn a small mistake, over funding your taxes, into a giant financial leap ahead. There are some great things to accomplish when you get a lump sum of money. Here are a few.
1: Fill the emergency fund
If you do not have an emergency fund, you don’t need to read the rest of the list as this option should take priority over the others. Most Americans do not have any money set aside for an emergency. I recommend you work up to having the amount equivalent to six months of your expenses tucked away in a cash account to be used only in an emergency. This refund is a great opportunity to jump start that account. You should keep this in either a money market account or CDs.
Only tap this account when you have a true emergency. Losing a job is an emergency. Buying a new car is not an emergency. Make sure that once you set up this account, you leave it alone and forget about it. It is there to save you in a time of need, not to make down payments on stuff you want to buy.
2: Pay off debt
This has a great two-fold effect: Debt elimination will increase your net worth as well as decrease your household expenses. There is great peace of mind knowing you don’t owe money to anyone. If you happen to have an outstanding credit card balance that might be costing you 20% interest, then you will also be making a very good investment that creates a 20% return. That will be hard to beat.
One person I know got a lump sum that equaled the amount needed to pay off their house. That final payment removed their entire mortgage payment every month. That was a huge budget changer in their household. Read The Doctors Guide to Eliminating Debt for additional motivation to stop managing your debt and start eliminating it.
3: Make an IRA deposit
Funding your retirement is a great way to use a tax refund. In 2020 you can deposit $6,000, and another $6,000 can be deposited for your spouse. If you are age 50 or older, the maximum IRA deposit increases to $7,000 apiece. Everyone is allowed to put money into an IRA regardless of their income. Income levels only determine the tax deductibility status of the deposit.
4: Fund a college education
With rising college costs and student debt burdens, helping your children or grandchildren pay for college is a great way to use this money. You can open a 529 college savings account and let the money grow until it’s needed. It is a great feeling to help your kids get through college without a debt burden, allowing them to start their new life debt free. We are not sorry we did this for our kids.
5: Start your real estate empire
Many people want to invest in real estate but don’t have the down payment they need to get started. This could be the opportunity you have been waiting for. Using your tax refund as the down payment on your first rental property is a great way to invest your unexpected windfall. Read The Doctors Guide to Real Estate Investing for Busy Professionals to get started.
6: Make home improvements
The right home improvements not only increase your joy in life, but also increase the value of your home. Updating the kitchen gets more bang for the buck than putting in a tennis court. But if you are an avid tennis player, you may get great enjoyment over many years by having a court at your house, even though the cost of the court will not improve the value of your property. If you play several times a week, there will be no more waiting for a court, and think of all the gas you will save by not needing to travel to the tennis court.
7: Buy life or disability insurance
If you have been putting off buying life or disability insurance, now is the time to act. Many of us don’t carry the right amount of term life insurance or don’t even have a disability insurance policy. Since we are about seven times more likely to become disabled than to die during our working years, make this purchase a priority. If you are not sure how much life insurance you need, this article will help.
8: Start a side gig
Have you been wanting to get started in a side gig that requires an initial capital outlay? Here is your chance. Get the needed equipment, training, or the necessary hired help to get you underway. If you have been thinking about this for a while, but haven’t had the funds to pull the trigger, today is the day.
9: Invest in a mutual fund
If you don’t have a special place to use the money this year, you can open a brokerage account and buy a mutual fund. Choose an index fund, the S&P 500 index fund or a total stock market index fund are great places to start.
There you have it, nine ways to use your tax refund that will result in putting you in a better place financially. Don’t just blow this opportunity on a vacation or a new car. Put those things into your regular budget and save up for them. Use the unexpected windfall to improve your financial life and you will reap the rewards for years to come.