How to Break Free From Debt and Get Ahead With Your Tax Refund

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How to Break Free From Debt and Get Ahead With Your Tax Refund

Get Ahead With Your Tax Refund

How to Break Free From Debt and Get Ahead With Your Tax Refund - PinterestPay Bills, Settle Debt, & Grow Savings

By Sarah Sharkey

Fact-checked by Ellen Johnson

It’s tax time! Filing your taxes may be a less-than-enjoyable chore. But it’s all worth it when you receive your tax refund. 

A refund check can be a sizeable amount of money. And it’s a good idea to use those funds to get ahead financially. But where should you allocate these funds? The right answer depends on your current financial situation. 

Let’s take a closer look at how you can use your tax refund to move towards your financial goals. 

Key takeaways:

  • Using your tax refund wisely can help you get ahead financially.
  • The right place to spend your funds depends on your current situation. 
  • Paying down debt may be a great way to use your tax refund. 

Use Your Tax Refund to Pay Bills & Expenses

A tax refund can be a much-awaited financial windfall for many houses. That is especially true if your household is struggling to make ends meet. If you are behind on your bills, using your tax refund to perform financial triage is the best option.

How to Implement This Choice

If you choose to use your tax refund to pay bills, start with any bills that you are behind on, especially mortgages and car loans, since your assets could be taken away if you do not pay these bills.

Tax refund to pay expenses

Hopefully, you’ll be able to catch up on all of your bills. This will prevent further late payments from hurting your credit score.

Once you’ve caught up on any outstanding bills, consider saving for your next round of bills one month in advance. With that, you’ll have a bit of breathing room in your budget. 

Why This Is a Smart Move

Keeping up with your bills can feel like a never-ending treadmill. After all, life can get expensive. For anyone trying to make ends meet, a tax refund could help be just the boost your budget needs. 

Who Is This Best For?

Anyone struggling to keep up with their bills should consider this option.

According to a study conducted by NORC at the University of Chicago, over half of households with incomes of $30,000 or less planned to use their refund to cover bills. But only 25% of households with incomes between $60,000 to $100,000 plan to use it for everyday bills.

As your household income increases, you’ll be less likely to use your refund to cover everyday expenses. But regardless of your income, if you find this option helpful, take advantage of it.

Bring Down Debt With Your Refund

No one likes to have debt hanging over your balance sheet. Luckily, a tax refund could help you speed up your debt repayment plans.

How to Implement This Choice

If you find yourself with a tax refund, it is easy to allocate it towards your debt repayment.

Tax refund to pay down debt

The debt you apply the funds to depends on your debt repayment strategy. You might choose the debt snowball strategy in some cases, which means putting your funds towards the debt with the smallest balance. In other cases, you might prefer the debt avalanche, which means putting the refund toward the debt with the highest interest rate.

Ultimately, choosing the snowball or avalanche method boils down to your goals. Do you want to tackle the highest interest rate or wipe out smaller debts first? But whichever strategy you choose, the tax refund can be applied to the next debt you’re looking to eliminate. 

Why This Is a Smart Move

Debt can drag you down. Not only is the financial crush on your budget each month a challenge, but also, a higher revolving debt burden can lower your credit score.

First and foremost, using your tax refund to break free from debt opens the door to more financial freedom. Think of how you would feel without this debt holding you back!

Beyond that, paying down some of your debt could lead to an increased credit score. If you pay down revolving debt, such as a credit card, that will lead to a lower utilization rate. And with that, your credit score should rise.

Who Is This Best For?

If you have outstanding debts, then you should consider using your tax refund to pay it down.

But if you are debt-free or only have low-interest debt, then using your tax refund for another purpose could be a better idea.

Save Your Refund

Saving money is never a bad option! In some cases, the best move is to tuck your refund away for a rainy day.

How to Implement This Choice

If you want to save your tax refund, one of the best account types to use is a high-yield savings account. Your funds can earn interest within a high-yield savings account, and you’ll still have easy access to the funds whenever you need them.

Why This Is a Smart Move

A substantial emergency fund can significantly improve your financial outlook. With a well-stocked emergency fund, you’ll be better prepared for the unexpected expenses that life throws your way.

Most experts recommend tucking away between three to six months’ worth of expenses in an emergency fund. But if that is not a realistic savings goal for you, having something saved for emergencies is still better than nothing!

Think of the last time you encountered a major unexpected expense. For example, a car repair that busted your budget. Imagine how that situation would be easier to handle if you had your tax refund available in an emergency fund.

Who Is This Best For?

Building a stash of emergency savings is incredibly useful if you live paycheck to paycheck. As you build a cushion to dip into, tucking away your tax refund can be a big addition to the fund.

For those that are behind on bills or struggling to get out of debt, you’ll want to focus on facing the challenge directly in front of you. But for those that have put high-interest debt in their rearview mirror, putting your tax refund into savings could be the right choice.

Invest Your Refund

According to the study conducted by NORC, investing your tax refund is the least popular choice. In fact, less than 10% of households across all income levels plan to invest their refund in the stock market.

But if you are on solid financial footing, investing your refund could set you up for a brighter financial future.Tax refund for investment

How to Implement This Choice

First, you’ll need to decide what type of asset you’d like to invest in.

A few popular assets used in investment portfolios include stocks, bonds, real estate, and precious metals. Of course, this is by no means an exhaustive list of possible investments. But it may help you start thinking about which option would be best for you.

If you decide to invest in stocks, you’ll do so through a brokerage account. There are now many low-cost options available to new investors, such as those offered by Fidelity, Vanguard, and even robo-advisors.

Why This Is a Smart Move

If you are at a point where you want to put your funds to work for you, then investing in an asset is a smart move.

Who wouldn’t want their money to start working on their behalf? Through investing, you can grow wealth over time.

Who Is This Best For?

Investing is a way to put your money to work for you. Investing might be the next logical step in your financial journey for those who can confidently cover their spending and a sufficient emergency fund to boot.

Although investing in assets that build wealth is a great choice for many, it’s not the right choice for everyone. If you struggle to make ends meet, have a large debt burden, or lack an emergency fund, then you may want to hold off on investing for now.

Make a Major Purchase With Your Refund

If you have a major purchase on your horizon that you can’t avoid, then using your tax refund can be a smart move.

For example, you might choose to use your tax refund as a down payment on a vehicle or buy a much-needed appliance for your home. That’s one way to put your newfound funds to good use.

How to Implement This Choice

Before you jump into using your tax refund for a major purchase, consider whether or not you truly need the item. If you can get by without the purchase, you might want to forgo it. Instead, you could save that money or use it to tackle another financial goal.

If you decide that you cannot move forward without making this purchase, then make sure to shop around. You don’t want to overpay for anything. Whether you are looking to purchase a new vehicle or a big appliance, shopping around to get a good deal could help you save a lot of money.

Why This Is a Smart Move

We all need items to help us get through life. A few major purchases are things that most of us cannot do without. For example, you need a car to get to work and a refrigerator to store your food.

Unfortunately, these necessities for modern living come with quite a large price tag. Of course, you don’t want to overspend. But choosing to spend your tax refund on a major purchase that you cannot get by without is not a bad move.

In fact, choosing to use your tax refund for this purpose could help you avoid taking on debt. With that, if your tax refund provides the cash you need to cover a necessary purchase, don’t hesitate to move forward.

Who Is This Best For?

If you have a major purchase on the horizon, your tax refund could offer the funds you need. But before moving forward, consider whether or not this purchase is truly a necessity.

For example, using your tax refund for a vacation wouldn’t fall under necessary spending. However, making a down payment on a vehicle you need to get to work is something you can’t avoid.

Take the time to ensure that spending your tax refund is what’s best for your finances. Otherwise, you could regret the splurge later.

The Very Best Tax Return Use for Your Situation

The best use of your tax return truly depends on your situation. Here are some examples.Your best tax refund strategy

Debt Is Holding You Back

If you are drowning in debt, using your tax refund to pay down debt is a no-brainer. After all, every penny you put towards your debt moves you one step closer to financial freedom.

You Have Some Financial Wiggle Room

But if you already have a bit of a financial cushion, the decision gets a little more complicated. Weighing the choice between saving or an investment can be tough.

Luckily, it gets easier if you look closely at your financial goals. Consider whether you want to save for the long-term or the short-term.

If you want to tackle long-term goals, investing could help you reach your goals faster. For example, most saving for retirement will tuck those funds away into an investment account.

But if you have a short-term savings goal in mind, then putting those funds into a high yield savings account is the better move. For example, if you want to take a fun trip in the next year or so, then setting those funds aside in an interest-bearing account is a good choice. 

You Have a Big Purchase on the Horizon

If you have a big purchase on the horizon that requires financing, then the best use of your tax refund will look a little bit different. Instead of simply saving for the purchase, you might decide to work on your credit score to set yourself up for more significant savings when you do take out a loan.

For example, let’s say that you want to buy a house, but you have a mediocre credit score. Instead of putting your tax refund towards the down payment, you may want to use those funds to boost your credit score. That’s because a higher credit score can help you unlock the best available interest rates and potentially lead to thousands of dollars saved over the life of your mortgage.

So, how can your tax refund improve your credit score? There are a few strategies you could employ.

First, pay down any revolving debt that you can. That will lower your credit utilization rate and potentially boost your score. From there, consider a credit repair service or add more information to your credit report. The potential increase in your score could pay off big in the long term!

Tax Refund FAQs

Can I Use My Refund to Improve My Credit Score?

Yes, you can use your tax refund to improve your credit score.

One way to go about this is by paying down existing debts with your refund. With a decrease in your debts, your credit score may rise. Additionally, using your refund to start an emergency fund can help you avoid taking on debt in the future.

Is there incorrect information on your credit file? You may consider working with a reputable credit repair service or working to have the incorrect information removed by yourself.

How Should I Not Spend My Tax Refund?

If you receive a tax refund, the best thing to do is use it to further your financial future. The worst thing to do is spend it on something unnecessary.

While it is completely okay to treat yourself now and then, spending your entire tax refund on things you don’t need won’t help you achieve your long-term goals. Of course, it is tempting to spring for a nicer car or a lavish vacation. But choosing to allocate your tax refund towards your financial future is the best move.

How Do I Get the Most From My Tax Return?

Getting the most from your tax return starts by filing properly. You’ll want to properly claim dependents and any refunds you may qualify for. Once you have your tax refund, choosing to use the funds to tackle financial goals is a great move.

Sarah Sharkey
Sarah Sharkey
Sarah Sharkey is a popular financial journalist who has been featured in Bankrate, Money Under 30, GoBankingRates, and FinMasters. Sarah has a reputation for helping people develop smart money skills. Her passion for strong personal finance balance sheets shines in her blog Adventurous Adulting, along with her love for adventures.

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