What Should I Do With My Tax Return? Follow These Steps!

By Angela Johnson, CFP®

In fiscal year 2021, the IRS processed more than 261 million Federal tax returns and supplemental documents and issued just over $1 trillion in refunds to individuals. That’s an average of $3,831.

If you’ve received a tax return, what steps should you take to gain a financial advantage?

Before we talk about smart ways to use your tax return, it’s important to first make sure you don’t get a large refund next year. The goal is to neither owe nor get back any refund on your tax return. That would mean you absolutely nailed your tax liability!

BEST PRACTICE: DO A SIMPLE ANNUAL WITHHOLDING CHECK-UP AS PART OF YOUR ANNUAL TAX PLANNING

Try it now: IRS Tax withholding estimator

Since it’s not likely any of us can calculate tax withholdings to the penny, a good aim is a range of owing or getting a refund of ± $500. If you are outside of that range, use the estimator above and talk to your HR department to update your Tax Withholdings now. Like, before you get another paycheck!

Why? Because there is no reason to let the IRS borrow money from you all year and then refund it to you. You and your family would be better off having that money in your monthly budget to spend, save and invest each month. Please don’t fall into the trap of thinking of a tax refund like a savings account or mini-lottery that you get to blow on junk every year. It’s not.

Instead, make smart decisions with your money today that your future self will thank you for!

Now that you are squared away with updated withholdings for the future, what should you do with your tax return this year to gain a financial edge for the future? 

Apply your tax return to these steps. As you complete each step, if you still have tax return money left, move to the next step.

1. GET TERM LIFE INSURANCE.  This is Step 1 because protecting your income is the most important step to protect your family today. You need term life insurance in the amount of 10-15X your annual income if anyone relies on your income, and $250-500K in term life insurance for a homemaker, depending on number and ages of children.
2. BUILD YOUR STARTER EMERGENCY FUND.  Once you have the correct amount of term life insurance in place, next up is to save 1 month of expenses in a bank savings account.
3. WORK THE DEBT SNOWBALL.  Next, pay down debt (excluding mortgage and appropriate car payment.) NOTE:  What’s an appropriate car payment? One in which your interest rate is below 7% and the monthly payment is no more than 10% of your monthly take-home pay. REAL TALK: If your car interest and payment are above these guidelines, you need to sell the car and buy one you can afford. Why? Because you’ll feel less stressed about money and have more fun in your daily life without the anchor of a car you can’t afford.
4. FULLY FUND YOUR EMERGENCY FUND.  Once steps 1-3 are complete, build up 3-12 months of expenses in a high yield savings account. (Let us know if you’d like an invitation to Flourish.)
5. VALUES-BASED FUN. Once you’ve completed Steps 1-4, here is where you use your remaining tax return on something that aligns with your values. Examples could be taking a trip with friends, doing something fun with your family or treating yourself in another way such as dinner, a new outfit or a spa day. IMPORTANT: DO NOT GO INTO DEBT OR USE A CREDIT CARD HERE!
6. INVEST.  Invest for retirement in your company 401K up to the employer match, fully fund a ROTH IRA, then start an HSA.
7. LIVE DEBT FREE.  Use the debt snowball method again to pay off low interest debt such as vehicles, student loans and your mortgage.
8. COLLEGE.  Invest for kids’ college or future expenses, such as paying for a wedding. (This step can be worked at the same time as Step 7.)
9. INVEST MORE.  Reevaluate your retirement goals and how much you are investing for retirement. Max out retirement contributions, including 401K and ROTH IRA’s for each spouse if needed. For instance, if you’d like to retire early, you may need to max out your retirement accounts annually. If you got a late start, it’s likely you will need to max out your retirement investing as well. 
10. GIVE!  Routinely support your favorite charities, help someone in need and give offerings to your church.

By following these steps, you’ll create financial security now while building a future you won’t regret!

Ready to take the next step?