Finance Expert Reveals 2 Essential Tax Refund Strategies, One Method Liberates $200,000 Debt
Tax season is upon us once again and with it, comes the anticipation of receiving that much-awaited tax refund. The Internal Revenue Service (IRS) has already processed millions of tax returns, with an average refund of $3,182, according to recent data, per CNBC Make It. While it might feel like newfound wealth, it's essential to recognize that this refund is simply a return of the excess money you have paid in taxes throughout the year. Rather than viewing it as windfall income, financial experts advise using your tax refund strategically to achieve long-term financial goals.
Erika Kullberg, an attorney and personal finance expert, underscores the importance of using tax refunds wisely. She emphasizes that these funds should be directed towards bolstering financial security or tackling debt rather than indulging in frivolous spending. According to a Bankrate survey, only 11% of respondents plan to splurge with their tax refunds while the majority prioritize savings or debt repayment.
Kullberg advocates a two-step approach to maximizing the benefits of your tax refund. Firstly, she recommends shoring up emergency savings. An emergency fund, typically amounting to three to six months' worth of living expenses, serves as a financial safety net during unexpected crises like job loss or medical emergencies. Given the current economic uncertainties, Kullberg suggests aiming for a more substantial emergency fund, equivalent to six to nine months' expenses.
Once an adequate emergency fund is established, Kullberg advises turning attention to debt repayment. For individuals grappling with significant debt burdens, allocating the tax refund towards debt reduction can be transformative. Kullberg shares her personal experience of utilizing the debt avalanche method to eliminate over $200,000 in debt accumulated from law school. The debt avalanche method involves prioritizing debts based on interest rates, focusing on repaying the debt with the highest interest rate first while maintaining minimum payments on other debts. This strategic approach minimizes the overall interest paid, accelerating the path to debt freedom. While it may require patience and discipline, particularly for those with multiple loans, the avalanche method offers tangible financial benefits in the long run.
Alternatively, some individuals may opt for the snowball method, which prioritizes paying off debts with the smallest balances first, gradually progressing to larger debts. While this method may not be as financially optimal as the debt avalanche approach, it can provide psychological motivation by achieving quick wins.
Regardless of the chosen debt repayment strategy, Kullberg emphasizes the importance of aligning financial decisions with long-term goals. Even after building an emergency fund and clearing debts, she advises against frivolous spending. Instead, she suggests redirecting tax refunds towards other financial objectives such as investing for retirement or saving for future expenses. In addition to these strategies, it's crucial to understand the potential impact of tax refunds on overall financial health. While receiving a sizable refund may seem like a boon, it indicates overpayment of taxes throughout the year. Adjusting tax withholding to ensure a more accurate reflection of tax liability can result in increased take-home pay each month, providing additional funds for savings or debt repayment.