3 Smart Money Moves for Your Tax Refund or Stimulus Check
When a windfall hits your bank account—like those stimulus checks or that tax refund—it can be tempting to spend it all right away on the first thing that comes to mind, or use it to jump on the next crazy investing trend. (GameStop stocks and micro-investing, I’m looking at you.)
But here’s the truth: Trendy investing tactics and unplanned spending aren’t going to help you build serious wealth for your future. Take micro-investing, for example—it’s basically the same thing as investing your spare change, and you can’t count on it for long-term investments. In order to really build wealth and make your money work for you, it’s important to have a plan in place for the extra money that comes your way.
Instead of focusing on the short term, now is a great time to think about the bigger picture. What are your long-term financial goals? What’s your why when it comes to spending and saving money? Maybe you want to be able to buy a home, start a business, put money into a college fund, or leave a legacy for your kids and grandkids. If you use it intentionally and stay focused, any unexpected lump sum can get you closer to achieving your goals.
So before you spend or invest that money on impulse, here are some tips for using it in a way that will help you win in the long run.
1. Get Clear on Your Current Money Situation
The first part of making the most of this money is to evaluate your financial situation. Make sure that your Four Walls are covered (that’s your food, utilities, shelter and transportation—in that order). If you’re struggling to make ends meet in any of those areas, then your extra money should go toward that first and foremost.
If you’re all good in those areas, start thinking in terms of a step-by-step plan. I’m part of the team at Ramsey Solutions, where we have a simple plan called the 7 Baby Steps that has helped millions of people take control of their money, get out of debt, and build wealth. No matter where you’re at in your financial journey, you’ll fall into one of the seven steps, so take some time to figure out which one applies to you. I’ll break them all down for you in the next section and you can visit RamseySolutions.com to get the full rundown.
When you’re clear on where you stand now, it’ll be easier to figure out how to use your tax refund and stimulus check to their full potential. Now let’s take a closer look at the Baby Steps.
2. Get Your Financial House in Order
When you define which Baby Step you’re on, you’ll be able to use your extra cash to get organized and help move you from one baby step to the next. Here’s how I’d recommend using your extra money based on where you’re at in the Baby Steps:
Baby Step 1
If you haven’t started the Baby Steps yet or you’re currently on Baby Step 1, put your stimulus check and/or tax refund toward building a $1,000 starter emergency fund. I know that might not sound like much for an emergency fund, but the purpose of this is just to give you a buffer for any unexpected expenses that come up while you’re paying off debt.
If you qualified for a stimulus check this year, that alone means you already have enough cash for this, and you can go on to the next step.
Baby Step 2
Now it’s time to pay off all your debt (except the house) using the debt snowball. That means you’ll want to use your tax refund and stimulus check to fuel your debt snowball and get some of those loans paid off.
If you’ve never heard of the debt snowball method of paying off debt, here’s a quick rundown:
List your debts from smallest to largest (regardless of interest rate). Pay minimum payments on everything but the smallest one.
Pay off the smallest debt as fast as possible. Once that debt is gone, take that payment (and any extra money you have) and apply it to the second-smallest debt while continuing to make minimum payments on the rest.
Once that debt is gone, take its payment and apply it to the next-smallest debt. The more you pay off, the more your freed-up money grows and gets thrown onto the next debt—like a snowball rolling downhill.
Here’s an important tip: Making and sticking to a zero-based budget every month will help you make sure every single dollar of your income (including any extra money you get from the government) is being used the right way. This can make a huge difference in how quickly you’re able to save and pay off debt.
Baby Step 3
If you’re already debt-free, your tax refund and stimulus check can go toward building up your fully funded emergency fund. This should be enough money to cover three to six months of basic living expenses you’d need if you were to lose your job or have another major life event.
But how do you know if you need three months of expenses, six months, or somewhere in between? Well, if you’re young and single with a stable income or if you’re a two-income family, then three months should be plenty. If you’re a one-income family—or if you’re self-employed, paid on commission, or have a history of chronic illness in your family—six months of expenses is ideal.
In addition to using your extra money from tax season, you can build up this fund by selling things around your house that you don’t need anymore, taking on another part-time job or side hustle, cutting certain items out of your budget, and anything else that can help you cut back on expenses so you can save more.
Baby Step 3b
Baby Step 3b is saving up a 10 to 20% down payment for a house. This is an “extra” Baby Step that some people choose to do at different times depending on where they are in life. Some people go straight from Baby Step 3 to 4 if they’re debt-free but not ready to buy a house yet.
If you choose to do this step right now, your tax refund or stimulus check would be a great addition to your house fund! I recommend saving up a 20% down payment or more if possible, because then you’ll avoid something called Private Mortgage Insurance (PMI), which increases your monthly mortgage payment.
Baby Step 4
Baby Step 4 is to start investing 15% of your income in a 401(k) or IRA, so go ahead and use your extra money to give your retirement savings a boost. Note: This doesn’t mean micro-investing. That’s okay for short-term saving, but remember, it’s risky to rely on that for long-term investments. I’d recommend putting the money from your tax refund and stimulus check into a Roth IRA (that means you get taxed on the money you put in, but your investments can grow tax- free so you actually save more in the long run). Thanks to compound interest, even a small amount of money like a tax refund can grow into a pretty big pile of cash over time.
Beyond Baby Step 4, you’re going to save for your kids’ college fund (Baby Step 5), pay off your home early (Baby Step 6), and build wealth and give (Baby Step 7)—so your tax refund and stimulus check can go toward each of those goals. The best part about reaching the last Baby Step is that all your hard work has paid off and you get to live and give like no one else. Just think about all the ways your annual tax refund alone could help someone in need!
3. Stop Loaning Money to the Government
If you got a big tax refund this year, it’s a good idea to adjust your tax withholdings so you can keep more of your hard-earned money throughout the year. A big refund feels like a bonus when you get it, but really it’s kind of like loaning your money to the government—without interest. You may even want to find a tax professional who can help you get closer to breaking even with your taxes.
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Wherever you are on your financial journey right now, stay focused on your goals and be intentional about how you use any extra money that comes in. Your hard work really will pay off in the long run.
This plan works, you all—I made a ton of mistakes with money when I was in college, but I pulled myself out of rock bottom by budgeting, paying off debt, and following the Baby Steps. And I know if I can do it, you can too.
This article originally appeared in the July/August 2021 issue of SUCCESS magazine.
Anthony ONeal is a Ramsey personality and the national best-selling author of The Graduate Survival Guide: 5 Mistakes You Can't Afford to Make in College. Anthony travels the country teaching people how to build true wealth and how to get out of debt.
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