People look forward to tax time, or they dread it. If you are looking forward to tax time it means that you will likely be getting a tax return. So, now the question becomes, how should you use your tax return? If you are going to be financially responsible, there is a right and a wrong way to use a tax return.
Let’s talk about some basics of thought for tax returns.
First, don’t think of your refund as free money – or lottery winnings. It’s not, you earned this money, you worked hard for it, and then you loaned it to Uncle Sam, interest free, for a whole year. So, you have to think of it as money you earned.
The next thing is until you actually get paid, make sure you don’t spend your return. If you start spending your return before you get it, you will likely overspend it.
Last but not least, even if it is great, don’t spend your whole refund paying down debt.
So, how should you spend your return? Well, follow these steps.
One: No matter what size your return is, you will want to divide it into thirds. This way you can use your tax return for the past, present, and future. This is always a smart financial plan.
Two: Take the third dedicated to the past, and use it to pay down debts. Obviously you are going to want to pay down the debt with the highest interest rate first. This way you save more money in the long run.
Three: Now take the third dedicated to the present. This is the part you want to have fun with. Use this for something that you want or need in the present. Obviously it is going to be more fun if it is something you want. However, if there is something you need, then that is what you should spend it on, like brakes for your car, or your child’s private school tuition. This is the part you get to enjoy, but like any other time you get money you are not expecting, you have to evaluate if you have a real need for it, or if you can spend it on fun.
Fourth: Take the rest, which would be the third dedicated to the future, and use it in a way to help you with some aspect of your future. This can be for any number of things. You can put the money in a savings account that is set aside for emergencies, or for future plans, like retirement. You can put it in a rainy day fund for emergencies that might occur. You can put it in a college fund, or some sort of IRA or 529 to help your children and grandchildren. You decide what you want to do with it. Invest it, save it, or whatever is best for your personal situation.
This is the right way to use your tax return because it is an approach that will take care of a variety of wants and needs. If you were to take it all and pay off a debt, then you might splurge later because you need to indulge every now and then. You might pay off a debt, but have no money saved for a rainy day. So, what you need to do is think about things in a more rounded way. The thirds for the past, present, and future is a great way to manage your finances, especially the ones that you have been lending tax free to Uncle Sam for so long.