What to Do with Your Tax Refund? Save for Emergencies.

As tax season comes to a close, many Americans are excitedly awaiting their tax refund. While the average federal income tax refund is smaller this year, it still provides a financial boost of almost $3,000, which can be especially helpful for families of limited means. However, it’s important to allocate the money wisely to help stabilize finances and prepare for unexpected expenses.

The Importance of Emergency Savings

For many Americans, a tax refund is one of the few times they receive a large lump sum of cash. Allocating at least a portion of the refund into an emergency savings account or paying down debt is a smart option, particularly considering the possibility of a recession and ongoing inflationary pressures. According to the Consumer Financial Protection Bureau, a quarter of Americans have no emergency savings to cover short-term financial hardships.

Using tax refund money to repay money borrowed for unexpected expenses, such as medical bills or car repairs, can help improve financial stability. Paying down high-interest debt, like credit cards, is often more beneficial than depositing the money in a savings account. Setting aside some cash can help smooth out the effect of surprise bills or fluctuating income.

Managing Your Tax Refund Wisely

One recommended approach is the “past-present-future” approach, allocating approximately 30% towards paying off debt, 40% towards current needs or wants (including emergency savings), and 30% towards future savings goals, such as for college or retirement. However, these amounts can be adjusted according to individual priorities.

Standard rules of thumb call for a rainy-day fund that would cover at least three months’ worth of income or expenses, like housing, food, and transportation. However, even smaller savings goals can be helpful in building towards financial security.

When filing taxes, directing the IRS to split the refund between different accounts can be helpful in committing to savings goals. Additionally, viewing savings as “paying your future self” can help reframe the savings mindset towards a positive future outcome.

Related Facts

• The average federal income tax refund this year is almost $3,000.
• Allocating tax refund money towards emergency savings or paying down high-interest debt can help improve financial stability.
• Setting aside some cash can help smooth out the effect of surprise bills or fluctuating income.
• Directing the IRS to split the refund between different accounts can be helpful in committing to savings goals.
• Viewing savings as “paying your future self” can help reframe the savings mindset towards a positive future outcome.

Key Takeaway

A tax refund can be a significant financial boost for families of limited means, but it’s important to manage the money wisely to prepare for unexpected expenses and improve financial stability. Allocating at least a portion of the refund towards emergency savings or paying down high-interest debt is recommended. Using online tools, such as the IRS’s withholding estimator, can help adjust the amount of tax withheld from paychecks to improve cash flow throughout the year.

Conclusion

While a tax refund can be a great opportunity for a financial boost, careful management can ensure that the money is used to improve stability and support long-term financial goals. By prioritizing emergency savings and paying down high-interest debt, individuals can set themselves up for greater financial security in the future.