What NOT to do with your tax return!
It's that dreaded tax time again, and for those of you who are expecting a tax refund you are being bombarded with advertising trying to entice you to spend your refund on things you probably don't want or need.
In fact just yesterday I heard a radio spot trying to convince people to invest in themselves by investing their tax return in plastic surgery. I couldn't help but burst out laughing! Granted you may want a tummy tuck or a boob job but this is the farthest thing from an investment unless you are being paid to look a certain way. My guess is that if you are reading this article you are probably already conscious about how you spend your money, or are trying to make better financial decisions, and you realize that plastic surgery is not necessarily the best use of your tax refund.
So, if you are strong enough to resist the temptation to spend your refund on things you don't need, you are probably wondering what the next best use of this money is? Chances are that it has already been beaten into your head by the Dave Ramseys and Suze Ormans of the financial world that consumer debt is detrimental and that you should do everything within your power to pay it off as soon as you can! If you follow their advice every extra dollar you earn, or can squeeze out of your budget, is to be used towards snowballing your debt, including your tax refund! As much as I agree with Dave and Suze that consumer debt does not serve your financial well-being, and should be paid off as soon as possible, (the timeline of which is determined by your needs both physical and emotional), I'm here to tell you why you should NOT use your tax return to pay down your credit card debt, with a few exceptions of course!
So what should you do with your refund? Save it! Yes, I'm 100% serious and here's why:
One of the methods I use with my financial coaching clients is called "Saving Your Way Out of Debt." It can sometimes be a difficult concept to grasp solely because we have been told so many times, for so many years, by so many credible sources, that we must pay off debt immediately no matter what. If you are like most people you have likely experienced firsthand that these best laid plans never seem to work. Have you ever worked yourself to the bone to pay off a credit card only to have life throw you a curve ball and then end up right back where you started with maxed out credit cards? This is a very common roller coaster ride most people can't seem to get off of. However, when you save your way out of debt you break this constant up and down cycle, and when your debt is gone it stays gone.
Here's how it works:
Imagine this scenario; you owe $10,000.00 in credit card debt and are determined to get rid of it since, as you know, debt is bad. So you decide to give up things like eating out, new clothes etc. so you can put every extra dollar each month towards paying down this card. You are so proud of yourself because the minimum payment is $150 but you are paying more than double that at $400 every month. At this rate, this stupid card that is costing you 16.9% in interest, will be paid off in 31 months. This sounds doable, you can survive this bare bones style of living for 2 ½ years if it means being debt free right? Even better, when the card is paid off you will easily be able to start saving some of that money instead! Like most people you vow to never use the card again and to only keep it for emergencies once it is paid off.
The intention behind this scenario is fantastic but how often do we stick to our intentions without something or someone derailing us?
Now imagine you have been really good about sticking to this plan for the last year. It has been really hard but you have persevered. Now you only owe $6643 to the credit card. But, life happens and your car breaks down. This couldn't be more annoying, 'why me?!?’ The mechanic is estimating a $2000 repair to fix your transmission. How are you going to pay for this repair? You need a car to get to work! You have no savings since every dollar has been going towards your credit card payments. Unless you can sell something it looks like you are going to have to charge it, this is an emergency after all. But now, after all your hard work and an entire year of depriving yourself of any luxury you are basically right back where you started on the debt roller coaster. Once you charge that $2000 you now owe $8643 to your card which will take 25 more months to pay off! Take a moment to imagine how you would feel? I am guessing quite defeated, angry and possibly evendepressed. All your hard work and tenacity just flew out the window. It's gonna be really hard to stick to this plan going forward. You may even be thinking, 'why do I even bother???'
Now, let's play out the same scenario using the Save Your Way Out of Debt method; you owe $10,000.00 in credit card debt and even though you are determined to get rid of it you want to do it right. You never want to be in debt again. So you decide to take a detailed look at your spending every month, keeping things that make you really happy and make you feel fulfilled, but cutting things you wouldn't miss. Again, you are so proud of yourself because you have freed up the same $400 to use towards paying off your debt. Instead of paying the full $400 to the card you decide to pay $200 to your card (just make sure you are at least paying the minimum payment each month) and save the other $200. Granted, at this rate, with this stupid card that is costing you 16.9% in interest it will take 67 months to be debt free. That sucks, but it is only five 1/2 years, and that's the worst case scenario.
Granted, I'm sure you would prefer to be out of debt faster but here is why this method has helped so many clients get out and stay out of debt.
Again, imagine you have been really good about sticking to this plan for the last year. It hasn't been as hard as you thought because you have been very conscious of spending money on things you need and things that provide long term satisfaction. Now you have managed to reduce the amount you owe to the credit card to $7632. Again, life happens and your car breaks down. This couldn't be more annoying. The mechanic is estimating a $2ooo repair to fix your transmission. Ugh! You need a car to get to work! But in this scenario you have $2400 sitting in your savings accounts for emergencies and this definitely constitutes an emergency. Now imagine how you would feel in this moment, knowing you can pay for this repair outright, and that you still have money left in your savings. On top of that you know that you will continue putting money into that savings account each month, and even better, your credit card debt is still going down!!! Congratulations! You have just gotten yourself off the debt roller coaster!
So, do you know what you are doing with your tax return now? Hopefully you are going to stick it in a savings account. As with any good practice there are always exceptions and here are a few:
Wishing you a stress free tax prep and hopefully tax time becomes something you look forward to like I do!
It's that dreaded tax time again, and for those of you who are expecting a tax refund you are being bombarded with advertising trying to entice you to spend your refund on things you probably don't want or need.
In fact just yesterday I heard a radio spot trying to convince people to invest in themselves by investing their tax return in plastic surgery. I couldn't help but burst out laughing! Granted you may want a tummy tuck or a boob job but this is the farthest thing from an investment unless you are being paid to look a certain way. My guess is that if you are reading this article you are probably already conscious about how you spend your money, or are trying to make better financial decisions, and you realize that plastic surgery is not necessarily the best use of your tax refund.
So, if you are strong enough to resist the temptation to spend your refund on things you don't need, you are probably wondering what the next best use of this money is? Chances are that it has already been beaten into your head by the Dave Ramseys and Suze Ormans of the financial world that consumer debt is detrimental and that you should do everything within your power to pay it off as soon as you can! If you follow their advice every extra dollar you earn, or can squeeze out of your budget, is to be used towards snowballing your debt, including your tax refund! As much as I agree with Dave and Suze that consumer debt does not serve your financial well-being, and should be paid off as soon as possible, (the timeline of which is determined by your needs both physical and emotional), I'm here to tell you why you should NOT use your tax return to pay down your credit card debt, with a few exceptions of course!
So what should you do with your refund? Save it! Yes, I'm 100% serious and here's why:
One of the methods I use with my financial coaching clients is called "Saving Your Way Out of Debt." It can sometimes be a difficult concept to grasp solely because we have been told so many times, for so many years, by so many credible sources, that we must pay off debt immediately no matter what. If you are like most people you have likely experienced firsthand that these best laid plans never seem to work. Have you ever worked yourself to the bone to pay off a credit card only to have life throw you a curve ball and then end up right back where you started with maxed out credit cards? This is a very common roller coaster ride most people can't seem to get off of. However, when you save your way out of debt you break this constant up and down cycle, and when your debt is gone it stays gone.
Here's how it works:
Imagine this scenario; you owe $10,000.00 in credit card debt and are determined to get rid of it since, as you know, debt is bad. So you decide to give up things like eating out, new clothes etc. so you can put every extra dollar each month towards paying down this card. You are so proud of yourself because the minimum payment is $150 but you are paying more than double that at $400 every month. At this rate, this stupid card that is costing you 16.9% in interest, will be paid off in 31 months. This sounds doable, you can survive this bare bones style of living for 2 ½ years if it means being debt free right? Even better, when the card is paid off you will easily be able to start saving some of that money instead! Like most people you vow to never use the card again and to only keep it for emergencies once it is paid off.
The intention behind this scenario is fantastic but how often do we stick to our intentions without something or someone derailing us?
Now imagine you have been really good about sticking to this plan for the last year. It has been really hard but you have persevered. Now you only owe $6643 to the credit card. But, life happens and your car breaks down. This couldn't be more annoying, 'why me?!?’ The mechanic is estimating a $2000 repair to fix your transmission. How are you going to pay for this repair? You need a car to get to work! You have no savings since every dollar has been going towards your credit card payments. Unless you can sell something it looks like you are going to have to charge it, this is an emergency after all. But now, after all your hard work and an entire year of depriving yourself of any luxury you are basically right back where you started on the debt roller coaster. Once you charge that $2000 you now owe $8643 to your card which will take 25 more months to pay off! Take a moment to imagine how you would feel? I am guessing quite defeated, angry and possibly evendepressed. All your hard work and tenacity just flew out the window. It's gonna be really hard to stick to this plan going forward. You may even be thinking, 'why do I even bother???'
Now, let's play out the same scenario using the Save Your Way Out of Debt method; you owe $10,000.00 in credit card debt and even though you are determined to get rid of it you want to do it right. You never want to be in debt again. So you decide to take a detailed look at your spending every month, keeping things that make you really happy and make you feel fulfilled, but cutting things you wouldn't miss. Again, you are so proud of yourself because you have freed up the same $400 to use towards paying off your debt. Instead of paying the full $400 to the card you decide to pay $200 to your card (just make sure you are at least paying the minimum payment each month) and save the other $200. Granted, at this rate, with this stupid card that is costing you 16.9% in interest it will take 67 months to be debt free. That sucks, but it is only five 1/2 years, and that's the worst case scenario.
Granted, I'm sure you would prefer to be out of debt faster but here is why this method has helped so many clients get out and stay out of debt.
Again, imagine you have been really good about sticking to this plan for the last year. It hasn't been as hard as you thought because you have been very conscious of spending money on things you need and things that provide long term satisfaction. Now you have managed to reduce the amount you owe to the credit card to $7632. Again, life happens and your car breaks down. This couldn't be more annoying. The mechanic is estimating a $2ooo repair to fix your transmission. Ugh! You need a car to get to work! But in this scenario you have $2400 sitting in your savings accounts for emergencies and this definitely constitutes an emergency. Now imagine how you would feel in this moment, knowing you can pay for this repair outright, and that you still have money left in your savings. On top of that you know that you will continue putting money into that savings account each month, and even better, your credit card debt is still going down!!! Congratulations! You have just gotten yourself off the debt roller coaster!
So, do you know what you are doing with your tax return now? Hopefully you are going to stick it in a savings account. As with any good practice there are always exceptions and here are a few:
- If you already have 6-8 months of living expenses saved feel free to use your tax return to target your debt. If not, it's best to be prepared. Accidents can happen, you can get sick, and there may come a time where this savings will be all that stands between you and disaster.
- If you have multiple credit cards and are close to paying one off you could use a portion of your tax refund (less than a third ideally) to pay off that card, especially if it will make you feel empowered. Don't forget, if you do this and you used to pay $50 a month towards this card be sure to apply the Save Your Way Out of Debt method to this freed up cash. Perhaps add $25 towards the payment of another card and $25 towards your savings.
- If you haven't fully funded your Roth IRA for 2014 (you have until April 15 to make contributions for the previous year. It is a good use of your tax return to contribute. In a pinch you can always use your Roth IRA as an “emergency fund” since you can pull out principal contributions without tax penalties regardless of your age.
Wishing you a stress free tax prep and hopefully tax time becomes something you look forward to like I do!