I have $5,800 of credit card debt with a high interest rate.
This year I had a medical emergency and have depleted my savings, and have no savings cushion.
I usually get an approximately $2,500 tax refund every year.
How do I get the most out of my return? Rebuild my emergency fund, or pay my credit card debt?
My opinion is you must rebuild your emergency fund first. If you don’t then any unexpected expenses will just land on the plastic and you’ll be left with no emergency fund and more debt.
I’ve seen it happen over and over again. Someone with no emergency fund works hard to pay down their debt and some unexpected expense rears its ugly head. The debt lands back on the plastic and adds years to the time it will further take to get out of debt. Imagine if you did not have that emergency fund to draw on when you needed it most.
Having an emergency fund is really a critical component to deal with debt.
Also, if you are getting that much back it sounds like you need to adjust your withholdings. The good news is that doing so will give you extra cash each month to use to pay down your debt. You might want to look at the free service offered by ReadyForZero.com to get you on an optimal repayment plan.
Tax Withholding Adjustment
You can adjust your tax withholding by a specific amount to put more money in your pocket each month.
The goal of tax withholding is not to let the government use your money for free all year long and get a big refund, it is so at tax time you either get a bit back or owe a bit.
As the IRS says, “You should try to have your withholding match your actual tax liability. If not enough tax is withheld, you will owe tax at the end of the year and may have to pay interest and a penalty. If too much tax is withheld, you will lose the use of that money until you get your refund.”
You can use the online Withholding Calculator to help you determine what you should be claiming.
Here is what the IRS says about adjusting your withholdings.
“If too much tax is withheld, you may receive a large refund when you file your return. If you would prefer to receive the money during the year, you should see if you qualify to have less tax withheld. If so, give your employer a new Form W-4 showing more withholding allowances.”
Please post your responses and follow-up messages to me on this in the comments section below.Should I Pay Credit Cards Down or Create Emergency Fund With My Tax Refund? by Steve Rhode