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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