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For many Americans, tax season means submitting your return and looking forward to getting your refund. But this year may look different from recent years, when taxpayers might have used the money on a vacation or to fund another large purchase. Those facing financial challenges instead may be wondering how to use their tax refund to help them stay financially sound.
Among other things, the COVID-19 (coronavirus) pandemic has shown that economic stability can change in an instant. If you're expecting a tax refund this year and find yourself out of work or struggling financially, read on for ways your refund could help your situation. And even if you're financially stable, using your tax refund to help you prepare for any unfortunate situation that could pop up is a wise move.
1. Pay Urgent Expenses First
In times of need, certain expenses should come first. These include essentials such as food, medicine, housing and utilities. Once you ensure that you have enough money to cover your daily needs, consider using the rest of your funds to make sure you keep a roof over your head. Landlords and mortgage lenders may offer relief to consumers facing financial hardship, but if that's not the case in your situation, consider using your tax refund to maintain your living situation for the immediate future.
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2. Pay Your Credit Card Debt
Making your debt payments on time every month is important to your credit standing and to your financial stability. If you don't have a source of income or your income has been reduced, you can use your tax refund to make at least the minimum payments on all your accounts until your situation improves. (If you know you don't have enough money—even with your refund and any government stimulus money you've received—to pay your credit card bills, contact your creditors immediately to see how they may be able to assist you.)
If your situation allows, you may want to spend some of your refund to pay down high-interest credit card balances. This type of debt can be costly to hold over time, especially if you're only paying the minimum. Reducing your debt on credit cards that are costing you the most in interest can help you save money you can then use to cover your monthly expenses, add to your emergency fund or pay down other debt. Start with the card with the highest interest then, if you have enough left over, pay down the card with the second highest interest and so on.
3. Start or Add to Your Emergency Fund
If your income is stable for the moment but you're worried that could change, having cash reserves may make you feel more secure and prepared. An emergency fund is a savings account dedicated to covering your expenses when you find yourself short on cash.
If you don't already have a savings account dedicated to emergencies, consider using your tax refund to start one. If you already have emergency savings, consider using your return to add to it. While experts often advise keeping three to six months' worth of expenses in an emergency fund depending on your ability to fund it, even $500 to $1,000 is a good start. Once you're feeling more financially secure, consider making regular deposits into this account for future emergencies.
Not sure where to deposit your emergency savings? Consider putting the money into a high-yield savings account so you can earn a little extra interest over time than you would with a standard bank savings account. High-yield saving accounts allow you to earn up to about 2% annual percentage yield (APY), compared with the average rate of around 0.05% APY earned at conventional banks.
4. Consider Your Long-Term Financial Security
If you're lucky enough to escape the financial stresses of the current economic crisis, this is a good time to consider your financial future. Here are two actions you can take.
Invest in retirement
For younger Americans, time is of the essence when it comes to accumulating a sizable retirement account. Meanwhile, older Americans may hope to increase their retirement accounts before leaving the workforce. If you already have a 401(k) account, you could increase your contribution to it and use your refund for everyday spending.
If you don't already have a retirement account or an employer that offers a 401(k) plan, you could open an individual retirement account (IRA) or Roth IRA, both of which allow you to invest in retirement across a variety of securities. You can use your tax refund to open the account, then determine an amount you can contribute every month to increase your savings.
Prepay your mortgage
Putting extra money toward your mortgage principal is a good way to save some money on interest over time. To do this, contact your lender and tell them you want to make a separate payment in addition to your monthly loan payment to put toward your principal. (You may also be able to do this on the lender's website.) When the mortgage principal is reduced, the interest you pay on the balance should also drop. Depending on how much you're able to prepay, this move could shorten the time it takes to pay off your balance.
The Bottom Line
How you spend your tax refund will depend greatly on your financial situation. During this unprecedented time, make sure you prioritize your own and your family's essential needs. Once you've covered those, use any leftover money to help you get through the coming months and, if possible, prepare for the future.