If you are among the large majority of people who receive a tax refund, you will soon face this question:
“What should I do with my tax refund money?”
Most people have an immediate response to this question. Here are some common responses I receive when I ask this question:
- “I’m going to pay off my credit card with it.”
- “I’m going to buy something with it.”
- “I’m going to use it to pay my property taxes.”
Most people have an idea of where they will use their refund, but it is usually for something they feel is URGENT not the most IMPORTANT.
To maximize the use of your tax refund this year, I recommend you follow the following decision matrix. When you arrive at the step matching your current situation, you will have discovered the one that should help you most!
- Do you have $2,500 in your emergency savings account? If you do not, this is the best way to maximize your refund! It will create margin in your life and breathing room for your budget. I’ve never heard anyone say, “My biggest regret is that I saved too much money.” If you do have at least $2,500 in your savings account, move on to #2.
- Are you investing enough into your retirement account? If you are not investing enough to capture the full company match (or at least $100 if your company does not provide matching funds), this is your next step. We call this Rung Three of the I Was Broke. Now I’m Not. Ladder. Use the tax refund money to make up your retirement contributions for the 2013 Tax Year (you can do this through the personal income tax deadline of April 15, 2014). If you are investing enough into your retirement account, move on to #3.
- Can you completely eliminate a debt with the tax refund money? If you can, do it! If you have two or more debts you could eliminate (but have enough money to eliminate only one of them), choose the debt with the largest monthly payment. This will help you create more monthly margin. If you are not able to completely eliminate a single debt, apply the tax refund money to the smallest amount you currently owe using the Debt Snowball Technique. This is Rung Four of the IWBNIN Ladder. Already debt free except for your home? Move on to #4.
- Do you have at least 3 months of expenses saved up? If not, this is a great use of your tax refund money as it will build an even larger amount of financial margin. More margin equals less stress. If you have already achieved this rung (Rung Five), move on to #5.
- Are you investing at least 15% of your gross income into tax-advantaged investments? This is Rung Six of the IWBNIN Ladder. Use the tax refund money to build up your retirement, college, and dream investment accounts. You’ve become an incredible money manager at this point which means you will recognize how awesome it is to be able to boost these accounts with your tax refund.
- Attack the home mortgage. This is Rung Seven of the IWBNIN ladder. At this point, your tax refund will enable you to gain even more momentum toward complete debt freedom. Nothing better than that!
- Increase your investments to at least 30% of your gross income into tax-advantaged investments. This is Rung Eight of the IWBNIN ladder. At this point you are funding a legacy that will literally allow you to bless multitudes. Way to go!
- Fund a dream. This is Rung Nine of the IWBNIN Ladder – “Live a great life!” Use the tax refund to fund one of your dreams or someone else’s dream.
My one big EXCEPTION:
- An investment that provides immediate (or nearly so) additional income. Suppose you were receiving a tax refund of $4,000. If you had the opportunity to invest this money into business dream which will produce additional income for you, then it could be a great use of your tax refund. For example, you could use the money to purchase inventory for an on-line Ebay store. If this would allow you to produce additional income in the future, then it could be a way to multiply the impact of your tax refund.
What are you going to do with your tax refund?