For many, the New Year brings to mind renewed optimism about the things to come, including a potential tax refund from last year’s earnings. While it is fun to imagine all the things you could do with it, a tax refund can provide the financial boost many need to start an emergency fund, pay down (or pay off) debt and help with future expenses.
Some people may think that a tax refund is free money from Uncle Sam – but think again. Knowing how to leverage your tax refund wisely – as well as recognizing when your refund may be too high – can help make your tax refund work for you.
Best Use of Tax Refunds
Simply put, tax refunds are a portion of your earnings from the previous year. They are the excess tax collected by the federal and/or state government, which have now issued you a tax refund for this overpayment. Two of the best ways to leverage this money are to pay off high-interest rate debt and to start or increase your emergency fund.
Paying down debt with a high-interest rate saves you money and may help improve your credit score. For emergency funds, the rule of thumb is to have a reserve fund that covers between three to six months of expenses. This threshold will vary based on an individual’s or couple’s unique financial situation.
Do you have high-interest debt?
If yes, pay down your debt with your tax refund.
If no, start or add to your Emergency Fund with your tax refund.
Do you have an Emergency Fund?
If no, start or add to your Emergency Fund with your tax refund.
If yes, add to your Emergency Fund.
There are other ways to make your tax refund work for you. You could use it to add to or open a retirement fund such as an Individual Retirement Account. If you have a young family, you could start a college fund. You could invest in the stock market or invest in yourself by paying for a training program to jumpstart your career.
Depending on the amount of your tax refund, you could even start a business or prepay your mortgage, which could shave months or even years off mortgage payments. The key takeaway here is that you’ve worked hard for your refund so let your refund work hard for you.
Adjusting Your Tax Refund
If you’ve been receiving large tax refunds over the past few years, it may feel like an extra annual income you can count on. However, it means you have overpaid your taxes throughout the year and the U.S. Government is using your money as an interest-free loan. Ideally, you should strive for smaller refunds, where the taxes you paid are a little more than the taxes you owed for the year.
To do this, review your tax withholding status and the number of allowances you currently claim on your W-4 form given to your employer. The more allowances your claim, the less your employer will withhold. There are W-4 calculators that can help you determine the number of allowances to claim so you will strike the right balance.
Resources to Help
The world of personal income taxes is complex and we recommend consulting with your tax advisor for help. Travis Credit Union offers several resources that can help during tax season. TCU members receive a discount on tax services from TurboTax and H&R Block. Also, the IRS has resources to help you before filing your 2021 taxes.
If you are ready to make the most of your tax refund in 2022, consider saving your money in a TCU Jumpstart Money Market Account. This MMA account pays the highest interest for the lowest balances, so you start earning more interest on day one. For other financial and membership information, view our quarterly Smart Money Matters e-newsletter.
Your financial wellness matters at Travis Credit Union. Visit traviscu.org for more information about our products and services. You may also visit one of our 24 branches in Northern California.