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Should I pay off debt with my tax refund?

Taxpayers plan to use their refund responsibly
Posted at 7:06 AM, Apr 10, 2017

Are you expecting a tax refund this year, and if so, what do you plan to do with it? The annual survey by the National Retail Federation suggests that in 2017, almost two-thirds of taxpayers expect to receive a refund, and many of those taxpayers plan to use their refund responsibly by paying down debt.

Certainly there are people who will use their refunds to splurge — 8.7% of survey respondents intend to apply their refund toward a major purchase like a new TV or a car, and 10.7% intend to take a vacation using some of their refund. However, 35.5% chose the responsible path of applying their refund toward paying down debt. Approximately 48% of respondents chose another responsible path by depositing their refund in a savings account.

While the percentage of respondents planning to pay down debt is on the rise (up from 34.9% in 2016), the percentage of respondents planning to save their refunds decreased from last year's peak of 49.2%. That breaks a nine-year string of increased saving percentages, but that is not necessarily bad news. The percentage of people intending to spend their tax returns for everyday expenses is at an all-time survey low of 20.9%, therefore many of those who are not saving have likely switched to paying down debt.

Those who are saving would be wise to set their refunds aside in an emergency or rainy-day fund. "It's your best barrier from high interest rate debt," according to Greg McBride, Chief Financial Analyst at Bankrate.com.

The fund does not have to be in a separate account, but doing so can help to avoid the temptation to spend part of your overall rising balance. Make it a regular habit; McBride suggests that you set money aside with every paycheck to stock your emergency fund. "Have a direct deposit from your paycheck into a dedicated savings account. Even when unplanned expenses come along and wipe that out, that's proof that [the fund is] working," says McBride.

A budget can help you spot your greatest areas of need and allocate your tax refund where it can do the most good. Millennial Money Expert Stefanie O'Connell points out why a budget is so important, especially with irregular cash flow: "The critical thing is that you know exactly how much it costs you to live and work normally every single month at a minimum." O'Connell says that as long as you know your "financial viability make or break number," you will be able to determine accurately the amount of flexibility that you have in allocating money to debt reduction, savings, or other needs.

It's nice to have a tax refund to apply to debt or savings each year, but there is another, even more efficient way to use that money. Instead of overpaying and letting the government hold onto your money until refund time, adjust your withholding so that you are paying as close as possible to the exact amount of taxes that you owe. That way, the extra funds that would have come back as your refund can be applied to debt earlier, saving on interest. Similarly, you could place those extra funds in savings and make interest on it yourself instead of letting the government do so.

Regardless of your tax strategy, the important thing is that you make savings and debt reduction priorities. The National Retail Federation may not like that, since by definition you will be spending less, but tell them to relax. You will do your share of spending after you have dealt with your other financial needs.

This article was provided by our partners at moneytips.com.

To Read More From MoneyTips:

Should You Pay Your Taxes With a Credit Card?

Get Lower Interest Deals Based On Your Credit Profile

Retirement Savings Tax Credit


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