Priority List for Spending You Tax Refund:
- Pay toward high-interest debt
- Put money into emergency savings
- Put money into savings to pay toward student loans when you have to start paying those back
- Add money to retirement savings
- Treat yourself (within reason)
I will admit, I’m usually pretty boring with my tax refund spending. After I file my tax return and learn that I’ll be receiving a refund, I don’t splurge or buy any crazy luxury items. Instead, I try to pretend the money doesn’t exist so that I don’t miss it when I put it directly into paying off debt or into a retirement or emergency savings account.
Fresh out of college, I’d split my return evenly among paying down my car payment with a 7.8% interest rate, my student loan with a 6.9% interest rate, contribute to retirement savings, and a “rainy day” savings account. This allowed me to pay down $25,000 in student loans in less than 10 years. Being a recent graduate, I had to be very strict with my money. I created budgets every month, and once all bills were paid, I had less than $100 in “fun money,” for things like going to restaurants or to a movie, or buying clothes, and that was while working four jobs, including a full-time one that required a college degree! Every six months, there would be a negative balance when my car insurance came due. So needless to say, it wasn’t easy.
To understand where to put your tax refund, it’s important to know your financial obligations to help you create a budget.
Now that I own a house and am debt-free other than my mortgage, a portion of my tax refund is set aside every year for a home improvement project. One year it was used for a paved driveway. Another it was putting in a fence.
I always make sure to contribute about a quarter of my refund to my emergency savings account, with another quarter directed into retirement savings. Thank goodness for this strategy because the year we bought our house and were cash-strapped to begin with, we had to replace a large portion of our plumbing because of a collapsed pipe!
How I usually spend my refund:
- Put half into Roth IRA for retirement savings
- Spend about a quarter on a luxury item or home improvement project
- Put a quarter into my travel savings account
Sudhir Suchak, is a clinical assistant professor in the School of Management at the University at Buffalo. He teaches personal finance, among other courses. When he worked at HSBC, he also helped develop a personal finance curriculum that new employees have to pass before advising customers on financial issues.
“One of the things I’ve seen quite often is that they have failed to build up emergency savings for any hardships. We’ve seen that point quite clearly in the past year,” Suchak says.
He adds that it’s hard to pinpoint an exact percentage or dollar amount to put away because of each person’s individual financial situation. If you have high-interest debt, paying that off should be your priority, but it’s also important to set aside some for an emergency account. While that can be pretty difficult on a monthly basis, it might be a little easier when you get that cash infusion from your tax return.
“Living paycheck-to-paycheck is difficult. I know that myself, but a disciplined individual, no matter their age, can set aside a small portion of their income and perhaps spending less on those items that we call ‘must haves’ (eating out to dinner, going to concerts), and putting those off for later,” he says.
If you have student loans, you should consider paying more toward the ones with higher interest rates.
“While the federal government has put a pause on the student loan interest and payments, that is only temporary,” Suchak says. “You can set aside savings to pay toward that when the federal student loan payments begin to have to be repaid.”
Paying-off debt not only helps your financial wellness but your physical health as well.
“Financial distress could lead to increased mental and health issues on a prolonged basis, so these financial points are very important,” Suchak says.
In the past year, we’ve realized how critical financial fitness is, but Suchak says, we may need a little extra pick-me-up, so it is okay to use your tax return to treat yourself, within reason.
For me, that means putting some of it into my travel savings account so when the world opens back up, I can go on vacation. Not an immediate reward, but something to look forward to that will bring me more joy than a single splurge on a luxury item.
