It’s that time of the year again… My wife and I just wrapped up filing our taxes for the year. Boy, let me tell you that is on the top of my list for fun weekend activities. Oh well, with another winter weather watch squashing other plans, it was as good a time as any to knock it out. As it turns out, we are going to get a refund this year. So what the hell should we do with it?
Here are 5 great ways to spend it.
To be honest I have mixed feelings about even getting a return. We basically gave the government a loan, interest free, for the year. I would strongly prefer to have this money in my hands and working for me.
But on the other hand it does feel good to have some unanticipated income coming in. Besides, the thought of having to cut a check depresses me to even think about. So I will take that refund, thank you very much.
Do you have a refund coming in too? Yes? Don’t let it go to waste! Having a plan for your refund is one of my favorite Lazy Ways to Increase Your Savings Rate since you weren’t planning on having that money anyway. So, let’s put that baby to work!
Pay Down Debt
If you are new to the Financial Independence movement it’s likely you have some debt hanging out there. Whether it’s paying off credit card balances, paying down student loans, or making additional principle payments on your mortgage, debt pay down can make a big difference.
Debt paydown guarantees a return on your money equal to the interest rate on the debt. Say you have student loans with an interest rate of 6%. The amount of money to direct to pay the balance down will have a return equal to 6%. Try topping that with a savings account, or even bonds. You might best that number with the stock market, but over the short term it’s a coin flip at best.
The benefit is compounded when the refund is enough to pay off a loan. Not only do you have the return on the interest savings, but now you also have freed up additional cash flow that can be directed elsewhere. You can add it to your debt snowball or avalanche.
If you have a mortgage with Private Mortgage Insurance (PMI) it may be worth checking how close you are to a Loan to Value (LTV) of 80%. Why is this important? Once below a LTV of 80% PMI is typically no longer required. Dropping PMI could free up hundreds of dollars a month in additional cash flow! If you are in the ballpark, drop a line with your lender to see what they have to say.
Build Up Your Emergency Fund
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If you have less than $1,000 in liquid assets available, I suggest you start here. Have car problems? Your furnace went out? Hot water heater goes Kaput? Unexpected health issues? You know “real life” issues. This “starter” emergency fund is critical to help you avoid taking on consumer debt to cover these unanticipated expenses.
Beyond the starter fund, the conventional wisdom is to have 3 to 6 months of your spending saved up. How you go about doing this is up for debate. Many will stash the money in savings accounts so it is readily accessible. Others prefer to plow it into taxable investments that can be liquidated quickly if needed. This opens up the possibility of investment gains but also exposes you to market risks.
We in the Heartland on FIRE household keep the vast majority of our emergency fund in a combination of a conventional savings account and a high yield savings account.
Contribute to an IRA
You can fund a tax-advantaged retirement account and allow the balance to grow through the years. A few bucks now can make a big difference 10, 20, or 30 years down the line. As an example, a contribution of $1,000 now would likely be worth $4,661* in 20 years!
In 2019 you can contribute up to $5,500 to either a traditional IRA or a Roth IRA. Choosing between the traditional or Roth options is a personal choice and too complex to cover in detail here. But in a nutshell the choice comes down to income and expectations for your future earnings and spending. Either option; however, is far better than not contributing!
*Assumes an average return of 8%.
Invest in A Taxable Account
Not sure you want to lock up that money for a couple decades or more? Concerned you won’t have funds available for that “once in a lifetime opportunity”?
Putting your refund into a taxable account can offer the prospect of market gains with much more flexibility. Typically, retirement accounts cannot be accessed prior to age 59.5. (There are mechanisms for doing so such as Roth Conversions, Substantially Equal Periodic Payments, etc., but those are for another article). It should be noted that dividends and realized gains in these accounts are taxed. That’s the price you pay for flexibility.
Build your FU Money Stash
Many people find that they are working jobs that they are not passionate about. Sure, maybe they jumped into the professional with gusto, but over the years their enthusiasm has waned. This can happen for a number of reasons: monotonous repetition, added work responsibilities, workplace bureaucracy, clashing personalities, changing personal interests, corporate restructuring, etc. It happens.
If you see the writing on the wall and realize that your current job is not a “forever job” it is wise to build up your FU stash. This is a pot of money that allows you to cover your living expenses in the event you leave your job. Whether leaving for another employer or diving into a passion project with both feet, it is helpful to be able to do so without having to worry about paying the electric bill or mortgage in the short term.
Alternately, this money can be saved up for a specific short-term savings goal. It can be “dry powder” if you will, for those rare golden opportunities. This is where our refund is going this year.
Oftentimes, this money is stockpiled in an easily-accessible location, such as a savings account. Keeping a big stash of money out of the stock market is not the most optimized option of the all, but career circumstances can change in the blink of any eye. A corporate buy out can turn a rewarding job into drudgery. A respected boss can retire or jump ship.
Summary
You really can’t go wrong here. The most important thing is to be sure to give that refund a job! Don’t let it sit in your checking account. Somehow, sooner or later you will find that all that money has disappeared. Whether it’s through new clothes, fancy coffee, fast food, or something else, lifestyle inflation will suck it up before you know it. So, put that money to work with one of these 5 great ways to “spend” your tax refund.
