March 12, 2020
Over the next few weeks plenty of you will receive a refund on your federal tax return, and for those of you in states that charge income tax, you may get money back from your state treasurer as well.
The average federal tax return is in the vicinity of $2,800 or so. That’s a lot of money. And a lot of money is a lot of opportunity to make progress on important financial goals. Invest $2,800 in a Roth IRA today and in 15 years it will be worth nearly $6,000 assuming a 5% annualized return. Adding an extra $2,800 a year to your mortgage payments can be a big help getting it paid off before you retire. Or it’s an addition to your emergency savings funds that brings you more peace of mind.
The worst thing you can do right now, as you wait for your refund to hit your bank account is to not have a plan. Without a clear strategy for what the money will be used for it will likely just be spent mindlessly over the coming months.
I want you to account for every penny. You might divide it into multiple goals. That’s up to you. But here’s my recommendation of what to tackle, prioritized by what I think is most important:
Pay off high-rate credit card balances. For this to work you also need to be ready to live below your means and within your needs. It makes no sense to pay off this expensive debt if you are going to turn around and just charge up big balances you can’t pay off.
Add to your emergency savings. If you’re working toward having eight months of living expenses tucked away, your tax refund can be huge step forward. It’s been more than 10 years since the last recession. None of us know exactly when the next one will hit, but a) it’s been a long time and b) it’s a question of when, not if. That makes now an especially smart time to build up this account.
Boost your retirement savings. A Roth IRA is a fantastic place to park a tax refund.
Hire a financial planner. As I explain in my new book, The Ultimate Retirement Guide for 50+, there are plenty of certified financial planners (CFPs) you can hire on an hourly or project basis. If you find yourself confused or worried about a part of your financial strategy, working with a pro to crunch the numbers and talk through different scenarios can be a great use of a tax refund that will pay off for years to come.