Tax Refund Plans: Pay Off Debt or Build Savings?

As tax season is progressing, more and more people are starting to receive a tax refund. Many people are wondering what are the best ways to use it. I wanted to quickly post some ways you can use your tax return for maximum financial impact.
I’ve used both in the past and have been happy with the results.

Putting away some cash makes financial sense.

Putting away some cash makes financial sense.

Set Aside Some Money Into Savings

You should do this first if you don’t have at least one month’s worth of expenses in your emergency fund. As many people are finding out, they are a paycheck away from a financial crisis.

Some financial gurus, like Dave Ramsey recommend having a baby emergency fund of $1,000. I lean at examining your necessary expenses and budget accordingly. You want to make sure you have positive cash flow month to month.

Since this is your money, make sure you place it somewhere safe such as a FDIC bank or NCUA credit union. It would be better if  it is also a high interest savings account.

We personally use online banks like Capital 360, Ally, CIT Bank, HSBC Direct, and EmigrantDirect.  The advantage with high interest savings accounts is that you’ll have your money grow faster and still have convenient access if you need it for an emergency.

Having an emergency fund is something to be proud about and it can give you some peace of mind.

Pay Down Your High Interest Debt

If you have an emergency fund handled, then look at putting your tax refund towards paying down your debt. Paying down your debt can improve your monthly cash flow, which can give you some cushion. It really depends on how large your tax refund is, you can tackle reducing your debt either one of two ways, depending on your preference:

  • Go after your small debts and eliminate a few of them quickly.This debt snowball method could give you a psychological incentive to continue. Dave Ramsey notes that many problems can be overcome by psychology.
  • Put it towards the highest interest debt and gain a financial advantage. If you’re looking at a strictly numbers standpoint, this is the logical choice.

My advice would be to choose a method that will work best for you. If it works then it’ll keep you on course as you work your way to becoming debt free.

Build Savings and Eliminate Debt

Don’t let this be a one time shot, make it a goal to continue for the rest of the year. You don’t have to make it an either/or choice, I recommend checking out Debt Free Adventure’s 75/25 Method to accomplish both goals. I recommend automating the process and letting online bill pay and transfers do all the work.

What do you plan on doing with your tax refund?

Photo Credit: alancleaver_2000 and Untitled blue

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Elle Martinez helps families at Couple Money achieve financial freedom by sharing tips for reducing debt, increase income, and building net worth. Learn how to live on one income and have fun with the second..

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  • Dustin | Engaged Marriage Feb 20, 2010, 3:22 pm

    That’s definitely some solid advice. We used a similar approach with our tax refunds the past several years as one of the strategies that helped us achieve debt freedom! Keep up the great work with your finances, relationship and this blog.

  • Len Penzo Feb 20, 2010, 3:31 pm

    That is exactly how the Honeybee and I built our emergency fund, Elle. It is a painless and easy way to build a substantial emergency fund over time – especially for those who have trouble maintaining fiscal discipline.

    All the best,

    Len Penzo dot Com

  • Danielle Feb 20, 2010, 3:43 pm

    Great post. My hubby and I keep our finances completely separate. My portion of the tax refund (which was higher than expected due to my financially irresponsible purchase of a new hybrid vehicle last year) is going into savings to help me bolster my emergency fund. Hubby’s portion is going toward his highest interest debt.