What Should I Do with My Tax Refund?
This time of year, it seems that just about everyone is getting a tax refund check from the IRS. A lot of them see it as free money; they immediately take it to the local big box store and buy a large TV set.
People with more sense, however, tend to save this money for a rainy day or use it to pay off their debts. For them, the question to be answered is not, what should I spend the money on? but rather, how should I use my refund check?
Options for Using Your Tax Refund?
If you are a person with credit card debt, payday loan debt, or other high interest loans, the answer should almost always be to pay off debt first. Even if you have no other savings, paying off debt with interest rates higher than 15% should almost always be your first financial priority. This is because there is simply no other way to make this kind of guaranteed return in any investment. A tax-deferred savings account will be hard pressed to make back this kind of interest, even assuming that you are in a high tax bracket.
If you have debts with interest rates lower than 4%, it’s almost always a good idea to shore up your savings instead of paying off debt. This is because it is important to have emergency savings that can be used to pay for unexpected expenses without worrying about running up high interest debt. Since the return on any savings will be comparable to the amount of interest you’re paying in debt, it makes the most sense to stash this cash away for the future.
If you have debts with interest rates between these amounts, however, it can be more difficult to decide what to do with the money. There are several different factors that can feature into this decision, including how much money a person already has in savings, how much money the debt payments cost each month, and the person’s overall financial picture. While we’ll go into more details next week about what to do if you have debt that falls in this range, for now the easiest thing to do is to portion your tax refund check into both savings and debt repayment.