There are two different ways that people look at their tax return. One way is that it’s your money that the government is finally giving back. The other is that it’s free money, a bonus, that you usually get once a year. Either way you look at it, there are smart things you can do with that chunk of money hitting your bank account. If you’re one of the lucky people who gets money back during tax season, you’re probably considering what you should do with the money. Get more bang for your buck and consider doing one of these smart things.
3 Smart Money Moves To Make With Your Tax Return
1. Pay off debt
Using your tax return to pay off debt is perhaps the best option, unless you’re intentionally keeping your debt in order to improve your credit score, which isn’t necessarily recommended. Wouldn’t it feel so good to get a chunk off your credit card debt, car loan, or student loans? One thing I enjoy doing is to put my info into this loan calculator to see how extra payments will affect the life of the loan. The amortization schedule shows you how extra payments will affect how much interest you pay and what date you’ll have it paid off by.
Snowball Method
There are two methods that finance experts recommend in deciding which debt to pay off first. The first is the snowball method, praised highly by Dave Ramsey. With this method, you put all your extra money toward your smallest debt first. When that is paid off, you take whatever you were paying toward that and put it toward the next smallest debt. People like this method because it helps them gain momentum. You get a big win right away, which helps you stay in the game. Additionally, with each small debt that you fully pay off, the more money you have to put toward your big-ticket debts.
Avalanche Method
The second method for choosing which debt to pay off first is the avalanche method. With this method, you pick whichever debt has the highest interest rate and tackle that first. You’ll pay less money in interest overall, so if you can stay motivated, this is a great method to use. Sometimes your biggest debt can have the highest interest rate, so if you think that you’ll be discouraged tackling your biggest debt first, the snowball method might be for you. If you know that you’re going to stay on track no matter what, definitely pay off the one with the highest interest first.
2. Save it
Another smart move you can make with your tax return is to save it. The sky’s the limit for different things you can save for.
Emergency Fund
If you don’t have any savings at all, your first goal should be an emergency fund. An emergency fund should be 3 to 6 months’ living expenses. The purpose of your emergency fund is to cover yourself for… well, emergencies. This way, if you lose your job or have a sudden and extensive medical issue, you won’t be in as much of a financial bind. To create your goal, tally up how much you need to live off of for one month and multiply that by at least three. Three months is usually enough savings if you have a very steady job with a very steady income. You’ll want to save closer to six months of living expenses if you foresee a job change in the future or if your income fluctuates as it does for those who work on a commission or are self-employed. If you already started an emergency fund, you can always use your tax return to beef it up a little.
Read more about emergency funds here.
Car Maintenance
Another smart thing to do with your tax return is to save it for car maintenance. This is especially important if you have an older car. Our savings account for car maintenance also doubles as savings for a down payment for a new car when the time comes. For that reason, we try to save more than we actually think we need for repairs. When it comes time for us to buy a new car, we hope to have a significant portion of the total price of the car already saved.
Other small savings accounts
We have several small savings goals besides our emergency fund, such as a travel fund. One thing you can do with extra cash coming in is to put all or part of it to complete one small savings goal. This would, first of all, feel really great. I love reaching my savings goals. It’s like the sticker chart of the adult world. But it would also free up money in your monthly budget to go toward something else. You could put the extra money in your monthly budget toward another savings goal, like your emergency fund, or put it toward debt.
3. Invest it
If you’re out of debt and you’ve got your savings accounts set up nicely, then another smart move to make with your money is to invest it. There are several different ways–some more obvious than others–to invest your money.
Stock Market
Investing in stocks is the first and most obvious way to invest. I would be lying if I didn’t say that the stock market still intimidates me a little bit. But I’m learning that it doesn’t have to be nearly as complicated as I think. I really appreciated this post over on the Frugalwoods blog. A good rule of thumb is to invest money for things that are at least 5 years in the future. For instance, we know we won’t be buying a house anytime soon, so we will probably create an investment account in which we’ll start saving for a downpayment for a house.
Retirement account
If you haven’t started a retirement account, do it now. One thing that motivated me to keep putting money into my 401k is realizing the difference between saving for retirement in your 20s vs your 30s. This article breaks it down really well. If you’re already in your 30s and feeling kind of anxious because you didn’t start saving in your 20s, don’t let that keep you from starting now! And if you already put money into your retirement account, I’m sure it wouldn’t hurt to beef up your retirement account if you already have one.
Home repair
I list this last because it isn’t always the smartest investment. However, if you know that you’re going to need to sell your house sometime in the future and there are some easy updates you can make to improve the worth of your house, definitely look into it. I am not speaking not from experience, as I have never owned a home. But I hear that the key to this is to do your research. Make sure the updates to your home are actually an investment and not just money that you’ll never see back.
Our Plan
We have a separate savings account that we’re putting money in every month for college applications and GRE testing. It’s nice to save now since we know those are some big expenses coming our way later this year. Our plan is to put part of our tax return to reach that savings goal, then put the rest toward our emergency fund, in which we’re about halfway to our goal. This will free up $75 in our monthly budget to put toward something else. We’re going to put that money toward our emergency fund as well. Using our tax return on both these things will completely cover grad school applications AND help us reach our Emergency Fund goal 1 year and 7 months sooner! It’s definitely a win-win.
P.S. You might also be interested in 7 Tips to Make Tax Season Easier!
