This is another guest post from Joe Plemon from Plemon Financial Coaching. Joe is the Money Columnist for The Southern Illinoisan.
Q: Joe, we have just filed our taxes and are going to receive a $4,800 refund. Should we use this money to pay off credit card debt or invest it for retirement?
A: The “Baby Steps” approach, touted by Dave Ramsey, will not only answer your question, but will give you a methodical money plan for the rest of your life. Let’s walk through these steps in order.
Dave Ramsey’s Baby Steps
- Baby Step One: $1,000 in an emergency fund. If you don’t already have $1,000 set aside for small emergencies, you should do so with the first $1,000 of your refund.
- Baby Step Two: Debt snowball. Use the remaining balance to pay off debt, other than your house, progressing from the smallest to the largest.
- Baby Step Three: 3-6 months of expenses in fully funded emergency fund. If you have any money left after the first two steps, use it to build up your emergency fund. A fully funded emergency fund is especially significant in today’s uncertain economy.
- Baby Step Four: Invest 15% toward retirement. I imagine that you used all of your refund in the first two or three steps, so this one will need to wait until you are out of debt and have a great emergency fund.
Three remaining Baby Steps are:
- Five: College Funding.
- Six: Pay off House Early
- Seven: Build Wealth and Be Very Generous.
You didn’t ask, but I must challenge you about the wisdom of receiving such a large refund. Remember: this is YOUR money. When you get a refund, the IRS is returning the money you have loaned them interest free over the past year. $4,800 is $400 a month you could have been using to pay off debt this past year. I urge you to change your W-4 form so you can have this money in your hands instead of the government’s hands. One caveat: give the money a name so it won’t disappear.
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When people ask me what they should use their refund money on my advice usually follows Dave Ramsey’s steps pretty closely. Just this past week I convinced two people to start emergency funds and talked with my brother about him paying off his car (which he did!).
Not to toot my own horn, but since I’m pretty well set in most of the baby steps, my refund is paying for my honeymoon later this year.
I’ve been working through the baby steps for quite a while now as well. When we got our refund check, we actually decided to that we had outstanding balances with before sending the money to credit card companies. Although we could have saved a bit of money by paying off the cards first, I feel morally obligated to support our local businesses as a priority, especially since they probably need the money even more than the credit card issuers.
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These are all great; I’m continually dismayed when I see folks blow it on a big screen TV and continue to carry debt and not prepare for the things they’re going to need later for themselves and/or their children.
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These are important suggestions for what to do with the tax refund check, especially paying down debt and setting aside for an emergency fund. Everybody needs to be prepared if that unfortunate day comes when they need an emergency resource of funds!
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