Tax season usually evokes feelings of dread, anxiety and stress, but there is one thing that gets people excited: the arrival of their tax refund.
If you file your taxes every year, you probably already know what a tax refund is: It’s a refund you get from the IRS if you overpaid in taxes that year. According to the Treasury Inspector General for Tax Administration disclosure, the IRS received more than 137 million tax returns during the 2015 tax filing season and issued more than 100 million refunds totaling around $270 billion. The average tax refund was $2,701, a slight increase from the year before.
Two thousand dollars can go a long way, especially if you’re looking to improve your finances. According to the National Retail Federation’s annual Tax Return Survey, 39.1 percent of consumers had planned to pay down debt with their tax refund in 2015; 46.9. percent planned to put it in savings.
How Americans Planned to Spend Their 2015 Tax Refund
Note: Survey respondents were asked, “What do you plan to spend your refund on? (Check all that apply)”. The sum of the % totals may be greater than 100% because the respondents can select more than one answer.
When you get your next tax refund, you might choose to use it to build your savings or pay off debt. But how do you decide between putting the money in a savings account and using it to pay off loans and bills?
Below are some tips to help you decide on how you should spend your tax refund.
When to Use Your Tax Refund to Pay Off Debt
Paying off debt can feel like you’re trying to lift a huge weight off your shoulders. Typically, getting out of debt is a long process that requires careful planning and budgeting as well as patience. So, it’s understandable why you might want to use your tax refund to pay off your credit card debt, your mortgage loan, car loan or even student loans.
But, you might have a little nagging voice in your head telling you to save your tax refund instead. Here are three reasons to prioritize paying off debt over saving money when you receive your tax refund:
- You can pay off a bill ASAP. Depending on the size of your tax refund and how much debt you have, you might be able to go ahead and finish off some of the smaller bills, such as credit card or utility bills.
- You can buff up your debt snowball. With that extra money, you can go ahead and build up your debt snowball to pay off the rest of your debts even faster.
- You can improve your cash flow. With a debt or two removed, you can then give yourself a bit of wiggle room in your budget and start saving more money. So if an emergency happens, you’d have a bit of cash to spare if you need to use it.
It might seem like a no-brainer to use your tax refund to pay off your debt first instead of saving it. After all, it’s extremely difficult to save money if you have a ton of debt holding you down. Still, there are times when you should opt to put your tax refund in a savings account instead.
When to Use Your Tax Refund to Build Your Savings
For some people, going into full debt-elimination mode without having some sort of financial cushion might not be the best strategy. When a financial emergency or unexpected expense arises, you might need money to cover that expense. But if you’ve been focused solely on paying off your debt, you might not have enough money in your savings, forcing you to take out another loan or credit card — both of which just add more to your debt load.
If you don’t have a financial safety net, consider taking your tax refund and tucking it away into a high-interest savings account. That way, you’ll have easy access to your money in case an emergency happens. Plus, your balance will continue to grow thanks to the savings account’s high interest rate.
With that said, if you’re convinced that you need to use your tax refund to pay off debt, there’s a way you can make payments and save money at the same time — just allocate a portion of your tax refund to go toward your savings account and a portion to go toward your debt payments.
How much of your tax refund should you put in your savings? That depends on you and your situation:
- If it’s just you, and you don’t have any dependents: Your total savings account balance should be enough to cover at least one month of bills. Whether it’s $200 or $2,000, use a portion — or all — of your tax refund to bring your savings balance to that amount. Should you lose your job, you’ll have a few weeks to get something together going forward without having to put bills on your credit cards.
- If you have a family: Talk to your spouse about how much of your tax refund you want to put toward your savings. Perhaps the two of you feel that having a couple months of expenses gives you enough breathing room should one of you lose a job.
Whatever you decide, you can’t go wrong with using your tax refund to build savings or get out of debt. Just remember this: Don’t try to invest money intended for short-term savings. Investing in stocks can be quite volatile. Instead, keep it somewhere safe and easy to access.
Keep reading: How to Protect Your Tax Refund From Being Stolen
Sydney Champion contributed to the reporting for this article.