It is that time of year where employers are paying their year-end bonuses and people are hoping to receive a tax refund from the government. 2019 was a good year for many companies and according to one recent survey at least two-thirds of employers plan to pay a bonus for 2019 performance. Last year, almost 112 million people got a tax refund. Have you booked your trip to Hawaii, bought those cruise tickets now that they are at a discount due to the increased quarantine risk, or are you ready to buy the essentials, like the iPhone 11 with three cameras, with your bonus and refund?
Well, read these facts before answering:
- The average tax refund was almost $2,900. For a lot of people in the United States, their tax refund is their biggest single check of the year. In fact, 44% of Americans said their tax refund would be their biggest check of the year.
- A 2018 report by the Federal Reserve showed over 40% of Americans cannot afford to pay for an emergency that exceeds $400.
- 25% of Americans have no retirement savings or pension. According to the report, 42% of people aged 18-29 have no retirement savings, along with 26% of Americans in the 30-44 age bracket. Among those closer to retirement, 17% of people aged 45 to 59 have no retirement savings and that figure is 13% for those people aged 60 years old or older.
- The credit card debt balance for the average American, according to one recent survey, is over $7,000. The survey reported that 10% of Americans with credit card debt say it will take them longer than 10 years to pay it off, and 9% don’t think they’ll ever be completely free of it, according to our survey.
These dreadful facts are after 10 years of a growing economy. I wonder how things will look after we go through the next recession.
For many people, bonus checks and tax refunds are their chance to do something meaningful towards achieving financial security. I wonder how many people squander away that opportunity every year.
I did not get to many tax refunds during my working life but I did get a lot of end-of-year bonuses and I used them to get ahead with my financial situation. I saved/paid down debt/invested 75%-100% of any bonus I ever received. It felt great to get ahead with these annual bonuses when they did arrive in my account.
How to Use Your Refund and Bonus to Move towards Financial Independence
If you already have zero consumer debt, an emergency fund, and substantial savings in your 401K then you are in good financial shape but there are still things you can do with your bonus or refund that will move you closer to financial independence. Here are my recommendations, in order, on how to use your tax refund and annual bonus:
- Pay-Off High Interest Debt – This is a no brainer with credit card interest rates above 18% annually. If you have existing credit card or other high interest debt that is not being paid off monthly then use your bonus or refund to help get rid of it. WARNING – Do not then go and replenish your debt levels. If you are reading this article and want to improve your financial situation then the first step is to permanently get rid of high interest debt.
- Build that Emergency Fund in a High Yield Savings Account – Many of the investments you have or will eventually have will not be liquid. This means you will not be able to sell them and get the cash right away or if you can sell the investment you might have to sell it at a discount if you want the cash for an emergency. If it isn’t obvious, you also do not want to rack up high interest credit card debt when you have to pay for an emergency. Therefore, if you do not have any money put aside for the rainy days you need to get that done. Standard advice in terms of the amount to put into an emergency fund is 3-6 months of your expenses. I do not like seeing money not grow at all so I typically put my emergency fund cash into a high-yield checking account. These accounts currently earn you about 2% annually on your money.
- Invest It – If you have the first two recommendations covered then you should begin, or add to, your investments. I am not going to use this post to analyze every type of investment but for the average person you should evaluate whether to invest in your 401K, Roth or Traditional IRA, or your own investment accounts. I am actually using my bonus from last year, my last year of work, to purchase an investment through Real Estate Crowdfunding.
- Pay-Off Other Debt – If you are ahead of the game with your investments then I suggest you circle back and look at any other debt you have and consider applying the bonus to pay-down this debt. With all the talk about wiping out student debt I would not pay it down right now. Instead, things like your home mortgage can get paid-down early if everything else is in order. Remember, paying down your mortgage is a forced savings mechanism that builds up your home equity. As I have discussed before it can feel good to own your home free of debt and it can be a major hurdle to clear towards achieving financial independence.
A Fox Business survey said over half of Americans plan to use their tax refund to pay-down debt or save. I am not sure if I believe these people’s responses are reflective of the average American considering many individuals are in significant debt and cannot afford a $400 emergency. I hope we all do the right thing with our refund and bonus.
For those willing to do that right thing with your hard earned tax refund or bonus, congratulations!