4 Reasons to Use Your Tax Refund to Pay Down Debt
Paying your tax refund toward debt is one claim anyone can be proud to make.
How to use your tax refund wisely
A tax refund is money that you receive back from the IRS after you submit your income tax return. W2 workers fill out a W-4 form when they first get a job. This indicates how much money the government should withhold (take out) of each paycheck to cover income taxes. It’s based on your family size and number of dependents. If you are self-employed, then you generally make quarterly contributions to cover your annual withholding.
In many cases, you pay more than you need to pay to cover your income taxes for that year. So, when you submit your income tax return on April 15, the IRS will refund any overages. That’s where you get a tax refund.
Most experts will tell you that a big refund is actually bad. That’s because you’re basically letting the IRS keep your money interest-free. They’re not giving you a reward; they’re giving you back what you overpaid. Experts would recommend that if you decrease your withholding, you’d get more money each paycheck. You could use it for better purposes or even just move it to savings so it can earn interest.
Still, many people like getting a refund because it gives them a large lump sum of cash each spring. Just make sure if you’re one of these people that you know how to use your tax refund wisely!
This is our favorite way to use a tax refund. You could pay off one or two credit cards or use it to make an extra payment on your student loans. If you pay off credit cards, then you eliminate bills that you have to cover in your budget. This frees up cash flow so you can stop living paycheck to paycheck.
Extra payments on student loans can also be a huge benefit. When you make an extra payment, they don’t deduct interest charges, so 100% of the money pays off your principal debt. If you don’t have student loans to repay, you can use this same strategy for a debt consolidation loan, auto loan or your mortgage.
Tax refunds can also be used to generate lump sum cash amounts for settlement offers. If you have debts or bills that went to collections, try to settle for less than you owe. Settlements are generally done with a single payment, so lump sums from refunds can work well.
Want a new TV, smartphone or couch for your living room? Don’t put these big purchases on credit cards or take out in-store credit lines. Instead, use your tax refund to pay in full so you don’t need to worry about another debt.
Keep in mind that this tip is not telling you to splurge! Don’t go out and buy a top of the line VR headset because it’s cool. That’s a waste of your refund. But if your TV is getting old or you need a new smartphone, then using your refund makes sense.
Most people take summer vacations and a 2017 survey found about 90% of us rely on credit cards to do it. If you use credit cards to cover your vacation, then one of the souvenirs you get from your trip is debt. You could spend months paying off your trip or need to pick up a side gig to get out of debt.
Instead of giving yourself that headache, just use your tax refund to pay off the charges for the reservations. Plus, if you book your trip now, you’ll get better rates!
Don’t have a specific debt to pay or goal to cover with your refund? Instead of splurging on that VR headset, how about you invest the money?
Money Market Accounts are savings accounts that offer variable interest rates. They also offer tiered rates, so the more you save, the faster you earn. They usually require a minimum balance, so you need a lump sum of cash to get started. This is a great use for your refund.
You can also use it to invest in a Certificate of Deposit. This is a type of shorter-term investment that offers better growth than basic savings. You can get a 1-year CD, contribute your tax refund and next year you’ll have even more money in the bank!
Tax refunds can also make a nice stock investment or you can make an extra contribution to your IRA.
In 2017 the average household spent over $1,000 on the winter holidays. That’s a big expense that most budgets can’t handle. So, instead of going into debt this year, save your refund to start a holiday savings fund. Setting aside the money now avoids causing stress on your last few paychecks in the year. Plus, you have funds available so you can shop throughout the year and decrease your shopping stress!
Down payments typically give you better terms and monthly payments on loans. So, using your refund as a down payment can be extremely invaluable. Let’s say you want to buy a car this year. Although you may see plenty of $0 down offers, they usually cost more over the life of the loan that if you’d put money down. Tax refunds also make great injections into the down payment on your next home.