Should I Pay Off Debt or Save Money With My Tax Refund?

Few things feel better than receiving a hefty refund check or tax credit from the IRS. It can provide tremendous financial relief, especially now. There are plenty of ways you can use them to improve your financial situation, such as using them to pay off debt or save money, but you may be overwhelmed by all the options. To help you out, here are some smart ways to use your child tax credit or tax refund to create some breathing room in your budget.

Stock Up Your Emergency Savings

First and foremost, it's vital to have at least three to six months (in light of the pandemic, lean towards the higher end) of living expenses saved up. This will help you out in case of an unexpected expense or financial situation you may be faced with like a car repair bill, medical bill, or job loss. Living expenses include the barebones necessities (rent/mortgage, car payment, groceries, credit card minimum payments, etc.). Don't account for non-essential expenses like travel or dining out in your emergency fund.

As for the account type, go with a high-yield savings account. This can allow your money to earn a solid interest rate while stored away. Then, if disaster strikes, you have plenty of money to cover any necessary expenses without incurring debt.

Pay Down High-Interest Debt

Once you have an emergency fund stashed away, go after your debt. Start with high-interest debt — primarily, your credit cards and high-interest personal loans. These drain the most money from you in the form of interest. Consider prepaying your mortgage, auto loan, or student loans only after you deal with high-interest debt. These tend to have lower interest rates and provide you something of value (a home, a vehicle, and skills for employment). If you have federal student loans, you currently don't have to make payments due to COVID-related forbearance — so your money may be more useful elsewhere.

Regardless of your debts, though, you should consolidate and refinance them if you can before using your refund on them. Doing so will reduce the number of debts you have to manage and score you a lower interest rate. Paying off whatever's left after using your child tax credit or refund will be easier.

Take Care of Repairs

Whether it's your house or car, repairs and maintenance can be expensive. If you've covered your emergency savings and you don't have any high-interest debt, use your refund to take care of any repairs you've put off.

If you don't have any repairs or maintenance to worry about, consider opening a high-yield savings account specifically for repairs and put some of your tax refund or child tax credit into it. Like with your emergency fund, your money will earn a healthy interest rate while it sits waiting for use. Then, you won't have to go into debt the next time something breaks in your home or car.

Look to the Future

If you have the above situations covered, you can accelerate your progress toward your future goals. You can consider starting with your retirement. Consider opening an IRA, which offers tax advantages, to invest your refund for your golden years.

If you have or plan on having kids, think about their education. You can invest your refund or credit into a 529 plan. Contributions to these are often deductible on state taxes, and earnings/withdrawals are tax-free when used for qualifying education expenses. You can also consider giving your child a head start on retirement savings by opening them an IRA if they work and earn income. Consider contributing (out of your own money) as much as they make, up to a maximum of $6,000 for 2021.

Make the Most Out of Your Tax Money

A tax refund or child tax credit offers a welcome sum of cash you can use to improve your finances. Whether you need to stock up emergency savings, pay down some debt, take care of repairs, or prepare for the future, make sure to quickly outline your strategy for using your tax refund before it arrives. That way, you'll be ready to make the most out of your refund.

Notice: Information provided in this article is for informational purposes only. Consult your financial advisor about your financial circumstances.

Source: iQuanti, Inc.

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Categories: Personal and Family Finances

Tags: Debt, Personal Finance, Savings, Tax Refund