Household debt has reached unprecedented levels, hitting $18.04 trillion by the end of 2024, based on data from the Federal Reserve Bank of New York’s Center for Microeconomic Data. Historically, Presidents Day weekend sees a spike in tax filings, and many Americans might use their tax refunds to tackle some of this debt.
These refunds can significantly impact your debt situation. For instance, the IRS reported an average refund of $3,138 in 2024. But, is it always wise to funnel this money directly into debt repayment?
Before you start making any financial decisions, it’s crucial to confirm the exact amount of your refund. You shouldn’t plan until the refund is in your hands, but there are steps to estimate what you’ll receive. If you haven’t filed your return yet, using a tax calculator with your paystubs and forms like W-2s or 1099s can be handy. On the other hand, if your taxes are already filed, your tax return will indicate the precise refund amount, which also helps in tracking its status with the IRS.
Ensure your essential needs are covered before using your refund to pay down debt. Prioritize urgent expenses such as groceries and utilities, and check if your emergency fund is sufficient to manage unforeseen circumstances without incurring new debt. Pam Ladd, a certified public accountant from Knoxville, Tennessee, and senior manager of personal financial planning at the American Institute of CPAs, suggests using your tax refund to either establish or boost an emergency fund. Said Israilov, a financial planner in San Francisco, advises aiming to save three to six months of living expenses. “It’s reassuring when unexpected hurdles come your way,” Israilov emphasizes through email. If that target seems out of reach, start with a modest goal; even a few hundred dollars can serve as a buffer.
Once your essentials and emergency savings are squared away, it’s time to address your debt, particularly those with high interest rates. These include credit cards and personal loans, often carrying rates above 15% to 20%. Sarah Paulson, a financial planner in Appleton, Wisconsin, stresses the urgency of overcoming high-interest debt, as it can quickly spiral out of control. It’s effective to list your debts from the highest to lowest interest rate, then direct your refund towards the one with the highest rate while maintaining minimum payments on others—this is known as the “debt avalanche” strategy.
While the above advice provides a good starting point, it’s important to consider your personal financial goals. This is, after all, personal finance. What suits someone else’s situation might not suit yours. If there’s a lower-rate debt close to being fully paid and eliminating it would offer peace of mind, then it could be worth prioritizing. Alternatively, you might value investing your refund in retirement savings, a major life event, or even a vacation. Depending on your refund amount, you might even split it across various goals, allowing you to manage obligations without feeling restricted. Paulson advocates for the idea of treating yourself, saying, “It’s about finding a way that truly satisfies you, rather than something that feels good briefly but leaves you regretting.”
As tax time approaches, be wary of offers for tax refund loans from some tax preparers. While these loans can provide quick access to cash by allowing you to borrow against your refund, they often come with high fees and interest, as Pam Ladd cautions. Ultimately, you’re paying to use your money sooner, ending up with less than you would have by waiting. Unless you’re facing an emergency, such as a rent deadline, exploring these loans should be a last resort.
Patience can be worthwhile as the IRS typically issues most refunds within 21 days, and you’ll get your money even faster when you file electronically and choose direct deposit. Stay alert about refund scams, which could put you at risk for fraud and increase your financial burdens. Keeping these potential threats at bay will help secure your financial stability.
