The IRS has received about 54 million tax returns so far and is issuing an average refund of $3,182, according to the agency’s latest data.
While a refund may feel like a significant amount of new money hitting your bank account, it’s actually been your money all along. If you directed your employer to withhold too much from your paycheck each month, the IRS merely returns the amount you overpaid.
That’s why financial pros generally advise clients to put any refund money toward financial goals rather than spending it.
Many Americans have the right idea: Just 11% say they plan to use their refund to fund a vacation or a splurge, according to a recent survey from Bankrate. The largest proportion of respondents — 28% — said they planned to put their refund into savings, and another 19% said they’d use the cash to pay down debt.
In fact, the two most common responses are the exact order of operations recommended by Erika Kullberg, an attorney, personal finance expert and founder of Erika.com, where she offers advice on saving, investing and managing money.
“I’d start with filling up your emergency fund with your tax refund, if that’s not yet filled,” she tells CNBC Make It. “If that is filled, then I would move to the second step, which is to take a look at the debt that you have to repay.”
If you have debt piling up, now is the time to take action, she says.
“For paying off debt, I like to use the debt avalanche method,” she says. “When I graduated law school I had over $200,000 in debt. This is the method I used to get out of debt.”
Here’s how she suggests you might handle your refund this year.
Save for emergencies and tackle debt with your tax refund
Kullberg, like many financial pros, preaches safety first. Having emergency savings on hand means that you can handle a surprise expense without having to go into debt or tap investing accounts to cover a shortfall.
The typical recommendation is to hold three to six months’ worth of living expenses in such a fund to keep you above water in the case of a major financial jolt, such as a layoff. If you can, it may be wise to go even bigger, given the chaotic nature of the economy, says Kullberg.
“Especially now, it feels like six to nine months is a better benchmark,” she says.
If you feel secure in your emergency savings, you can move on to tackling debt, Kullberg says. Her suggested strategy is one of two common debt payoff methods recommended by money experts.
Under the so-called snowball method, you make minimum payments on all your loans, then direct any extra cash to the debt with the smallest dollar amount. The thinking here is that the success of paying off bigger and bigger amounts will help build psychological momentum.
Kullberg’s favored avalanche method is for the more mathematical-minded. Believers in this strategy focus on paying off the debt with the highest interest rate first.
For Kullberg, who had several student loans at varying interest rates, that meant aggressively paying down the principal on her highest-rate debt while making minimum payments on the rest. (Notably, she also refinanced the bulk of her loans.)
While it may take longer to check certain forms of debt off your list via the avalanche method, the thinking behind this strategy is simple. By paying off the loans with the highest rates first, you pay as little as you can in overall interest.
And if you’ve already built an emergency fund and paid off your debt, you’d still probably be wise to put your tax refund toward a financial goal rather than splurging, Kullberg says.
“It really depends on the person,” she says. “Taking a look at your financial goals, your financial priorities, and figuring out where it might make sense to put your refund toward.”
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