Tax return time is a good time of year to take a financial step forward without an impact to your day-to-day lifestyle (if you get a return). This is probably the only time of year I’m glad I have my townhome that is $80k under water. Well, not glad it is under water, but glad I get to deduct the interest!
I’ve read through a few suggestions of how tax returns can best be used to improve financial situations, added my own opinion, and created this lovely flowchart of how to make the most of this annual cash infusion. These are some of my references: Real Simple, Go Banking Rates, MSNBC Money, Kiplinger’s Personal Finance. I especially like the “What You Shouldn’t Do” section in Real Simple.
Pay overdue bills & establish an emergency fund.
Both of these should be done first to “stop the bleeding”. Getting yourself current on your bills will help improve your credit score (and stress level). Establishing an emergency fund will prevent you from reaching for credit cards or other high interest debt options to pay for car repairs, house issues, or other emergencies that come up. One-thousand dollars won’t cover a catastrophe, but it will cover most emergencies.
Most of my references had this listed last, but I chose to have it further up the list. I think setting aside money for a personal indulgence, whether it is now or a few months from now, will prevent you from reaching for a credit card. You should be able to enjoy a small indulgence for sanity reasons and limiting it to 10% will ensure you still have enough to make progress on other financial goals. I plan to use mine on new clothes when my butterfly on the right toolbar hits 10 pounds lost.
Pay toward high-interest debt.
Credit cards are expensive, but they aren’t listed first because building an emergency fund and paying off bills will prevent the need to use credit cards. The first step to paying off cards for good is to only use them if you can pay the full balance every month. When I accumulated credit card debt, I wasn’t able to make progress until I set a fixed monthly payment and stopped using them. Before that, I would stretch myself to make really high payments and then resort to using credit cards when I didn’t have the cash in my checking account. In this case, slow and steady wins the race.
Build up a healthy savings account.
Life happens. Unfortunately, you can’t always plan for it. I think we all felt that in some way after the economy crashed in 2008. The recommended amount to have in savings varies from 3 months to 9 months, depending on the source. The best advice I’ve heard is to figure out how many months it takes, on average, to find a new job in your field and strive to put that in savings.
Save for large planned expenses.
I think this one is pretty self-explanatory!
Start an IRA.
Roth IRA’s are a great retirement vehicle because the money is not taxed when you take disbursements at retirement. This is because the money was already taxed when you put it into the IRA. About.com has a good explanation of the difference between a Roth and Traditional IRA and the benefits of both.
I did not mention anything about 401k here because my recommendations are focused exclusively on what to do with an annual cash infusion. I think it is important to use part of your raise to adjust your 401k contribution, which I discussed in a previous post.
Work on your cash flow.
Good job if this is you! It can take years to get here, so don’t beat yourself up if you aren’t. You’ll get there with a little patience and dedication. This is where you put extra money toward your student loans, car loan, or other debt not considered high-interest. You might not cover the full loan in one year, but you will be glad you did this when the loan gets paid off early!
Tax returns, in general.
If you’re getting a lot back every year, you should look at your withholdings. While it is nice to get an annual payout of cash, it is even nicer to have that money throughout the year.
What will be your indulgence with your tax returns this year?