April is known for many things, not the least of which is tax time. It also means that many people will be receiving a large income tax refund this time of year. So what do you do if you suddenly have a large sum of money in your account?
Let’s go shopping and have a party tonight!!!!
OK. That’s probably not the best approach, though it’s probably what many people do. If you suddenly find yourself with a nice little sum of money, you want to make sure you use it wisely.
Step one: Get it out of your checking account!
So the first thing you need to do is put the money somewhere just a little bit inconvenient. Do not leave it in your checking account. Move it to a savings account or some other account other than the one you typically pay your bills from.
Here’s why. If you leave it in the same account you where you typically pay the bills, you’ll find the money gets frittered away a little here and a little there. Feeling tired on Friday night after a long week’s work. Let’s just go out to eat. After all, I know there is this extra money in the account. I see that gadget I’ve been thinking about getting. Well it’s only a few dollars and the money is sitting there. Etc. Etc.
Before you know it, you’ll realize a month later that half the money is gone and you really don’t know where it went. By putting it in a savings account or some other account that’s at least a little inconvenient, you force yourself to have to do a transfer or take a trip to the ATM if you want to spend the money. That little bit of inconvenience will stop you from making impulse decisions and force you to make a conscious decision when you choose to spend the money. That doesn’t mean you still might not blow it, but you at least add some extra steps to the process.
Step Two: Have a plan
Just like you need to have a budget and spend your pay check on paper on purpose before the month begins, you need to do the same with your tax refund.
Spend some time considering how to best use that money.
Step Three: Make it count
This large tax refund provides you with an opportunity. Take advantage of it.
- Pay off some debt. If you are working the debt snowball how much progress will your refund allow you to make?
- Save it. Do you have an emergency fund of 3-6 months of expenses? This would be a great chance to put a little margin into your life.
- Do you have a Roth IRA? If you are within the income limits, you can contribute up to $5,500 in 2013 to a Roth IRA. ($6,500 if you are over 50). A Roth IRA would be a great use for those extra dollars.
- Do you have a car that is showing signs of age? How about putting aside a good amount so you can pay cash for your next vehicle and eliminate car payments once and for all by saving up and paying cash.
- Make an extra payment or two on your home mortgage. Extra principal payments can save you months off your repayment schedule and hundreds if not thousands of dollars in interest.
- If you have a higher interest rate on your current mortgage and are planning to stay in your home for the foreseeable future, consider refinancing and use the money to pay the closing costs.
- Do you have young children? How about starting a Coverdale ESA or investing in a 529 plan to start saving for their college.
- Have some home repair items that have been needing to be done? New roof or siding? A room that needs remodeled? Some appliances that are nearing the end of their life?
- Need some dental work? Kids need braces? Perhaps LASIK surgery?
- Give to your church or a charity that you believe in
- Have an entrepreneurial spirit? Tired of your current job? Need a job with a better income? Use the money to take a class or as seed money to start your own business.
- If you are out of debt and have a good amount of saving, use the money to plan a vacation. Create some memories that will last for a lifetime.
Step Four: Have some fun
It’s ok to take a portion of the money and have a little fun with it. Enjoy an extravagant night out with your spouse. Buy something you have been wanting. Pamper yourself with a trip to a spa or something that you wouldn’t normally do.
Step Five: Take a look at your withholdings
If you regularly get a large refund, that really isn’t a good thing. This isn’t free money from the IRS. This is money you paid in taxes that you didn’t need to. For example, if you get a $2,400 refund, you are essentially giving the government an interest free loan of $200 each month. This really isn’t smart.
Talk to your HR person at work. See what adjustments you can make to your withholdings so that it will more accurately reflect the taxes you owe. You don’t want to cut it too close so that you end up owing a large tax bill, but if you regularly get a large refund you should be able to arrange things so you get a little more in your pay each month.
Use it to make a difference
While this time of year we think of tax refunds, certainly there are other ways you could unexpectedly receive a large sum of money. Perhaps an inheritance. Perhaps a bonus from work. Maybe you win a contest. Regardless of the source, these are opportunities you can use to make lasting changes in your life.
Have a plan. You have a great opportunity. Choose where you can best use the money and do something meaningful this year.