Budget Guide: What to do with your tax refund?

Budget Guide: What to do with your tax refund?

This post is part of the series Budget Guide

Other posts in this series:

  1. Budget Guide: Your Children’s Future
  2. Budget Guide: 3 tips for big ticket items
  3. Budget Guide: What to do with your tax refund? (Current)

Here in the United States, tax season has wrapped up and, hopefully, you submitted your taxes by the April 18th deadline or filed for an extension. For many, the stress of tax season is often relieved when we are informed that we will be receiving a tax refund from the federal government, the state government, or both.

A tax refund is issued to a taxpayer when the amount of taxes owed for the year is less than the sum of the taxes withheld throughout the year from your paycheck plus any refundable tax credits that may be claimed.

So, if you are one of the millions of Americans who will be getting a refund check or two in the mail (or direct deposited into your bank account), what should you do with your tax refund? A lot of people view the refund as “free money” and then they spend it on expensive gifts, grown-up toys, or other things.

If you are on a budget and choosing to live within your means, here are some frugal ideas on how to make your tax refunds benefit you and your saving goals.

Pay towards loans and/or debt

First and foremost: if you are currently paying off loans or debt — credit card, student loans, car loans, mortgage — then it may benefit you in the long run to put all or part of your tax refund towards the principle of your smallest loan.

One strategy for getting out of debt, called the Debt Snowball, is to pay extra on your smallest loan. As much as you can reasonably afford on a regular, monthly basis. This allows you to pay this loan off faster. Then, when this smallest loan is completely paid off, you take the money that you have and use it as extra payments on the next largest loan. You are already used to not having that amount available for casual spending each month, so the best thing you can do is use that money to continue paying off any other loans or debt. You can visualize it as a snowball gaining momentum and size as it rolls down a hill.

Tip: Just be sure that you specify in your payments that the extra money is going to principle. Some banks and loan companies are sneaky or have hidden fees, so you want to make sure that your extra payments are actually going to pay off the loan itself and are not being used elsewhere.

Using all or part of your tax refund to pay towards the principle of your smallest loan/debt is a great way to get a large chunk of the debt paid off.

Create or add to your financial safety nets

Another way you can use your tax refund is to put a portion of it into your savings account. As we discussed earlier in the Budget Guide series, you want to establish a “fake zero” balance in your checking account. This is a certain dollar amount that acts as your $0. It is intended to be a cushion or safety net.

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Tip: This “fake zero” balance can be $100 or $500 or $1000 dollars — whatever you can build up to and is realistic for your income, expenses, etc. — but the trick is that you always view it as untouchable. The only time you should dip into this cushion is for a real, genuine, and unexpected emergency… such as an ER visit with a high deductible or an unforeseen car repair.

With so many Americans unable to pay even $400 for an unexpected emergency (see this article in The Washington Post), it is very important for your financial stability to have a “fake zero”. I really encourage you to try to work this fake zero up to $500 or $1000.

Once you have a “fake zero” safety net in your checking, you need to start building a completely separate Emergency Fund in your savings account. Financial experts encourage that this Emergency Fund be equal to 3 months income. This gives you and your family an even larger safety net should the unthinkable happen and you are unable to bring in an income for a few months.

Granted, depending on your income, living situation, and cost of living, it may take a while to reach the 3 months income goal. This is where your tax refund comes in handy! That can be a pretty decent sized deposit into your Emergency Fund.

Use it for car maintenance and repair

If you own a car, especially a car older than five years, you know the importance of keep your vehicle in good working condition. You may want to take your vehicle to a trust-worthy mechanic to be evaluated so you can plan for future maintenance costs. If you already have a list of repairs or routine maintenance that needs to be performed on your vehicle, you can use all or part your tax refund to tackle some maintenance or a major repair issue.

Living within your budget helps you enjoy a contented life without stress that debit brings. Click To Tweet

Some basic maintenance issues that can be easily overlooked include  changing your oil regularly, having low air pressure in your tires, and worn out or old tires that need replacing. Be sure to read your vehicle’s owner manual so you know how frequently you should get the oil changed and what the pressure should be in your tires for optimal gas mileage.

As for the worn out or old tires: it may seem like you are saving money by buying used or discounted tires only when you absolutely need to replace a tire, but this practice is not good for your vehicle and could also pose a safety hazard for you. It can result in uneven wearing of tires and increase the possibility of a blow out.

Tip: It is best to get all four of your tires replaced at the same time or as close together as you can afford. Also, you should have your tires rotated periodically so they wear more evenly.

Buy one or two big ticket items on your list

Perhaps you have been staying within your budget and diligently putting away a set amount of money each month towards the purchase of a big ticket item or two, such as furniture or appliances, that you need. Perhaps it is a new refrigerator or washing machine, or perhaps it is a new rug or dresser. Whatever big ticket item that you have been saving for, your refund can help.

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My husband and I have a list of big ticket items that we arrange according to priority and necessity. For example, we desperately needed a proper dresser in our son’s room to hold his clothes and other items like blankets. For his first seven months, we made do with a single drawer in a small hand-me-down desk/dresser and some cubbies in a bookshelf. However, as his clothes got bigger, they were quickly outgrowing the small drawer. We also knew we needed something tall enough to double as a changing table.

So dresser was on the top of our list since it was a valid necessity and needed within a certain time period. We were able to bargain hunt online until we found the right dresser for us, within our budget, and with free shipping. Then we used a portion of our tax refund to buy the dresser. It arrived a short time later, and just this last weekend, my husband and father put the dresser together for us. It fit the room perfectly, works as an amazing changing table, and can hold all his clothes, blankets, and other items.

Tip: If you do not already, I highly recommend that you keep a list of items that you need or want, prioritized by necessity and urgency.

You can use part of your refund to help you purchase the most crucial item, and you can also put away a certain amount of money each month towards this list. You may have to “make do” without an item for a few months, but it is worth the peace-of-mind knowing that you are staying within your budget, live within your means, and avoiding credit card debit.

In conclusion

Obviously, these are only a handful of suggestions on how you can make your tax refund work for you. There are other things you can do, such as go on a much-needed vacation or use the money towards a trip to visit family. Whatever works for you.

Just remember: living within your budget helps you enjoy a contented life free of the stress and worry that debit brings.

But godliness with contentment is great gain, for we brought nothing into the world, and we cannot take anything out of the world. But if we have food and clothing, with these we will be content.”

— 1 Timothy 6:6-8, English Standard Version

So what are you doing with your tax refund this year?

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