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Should I Pay Credit Cards Down or Create Emergency Fund With My Tax Refund?

Should I Pay Credit Cards Down or Create Emergency Fund With My Tax Refund?

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?

TMV

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The Answer

Dear TMV,

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.

Big Hug!

Should I Pay Credit Cards Down or Create Emergency Fund With My Tax Refund?
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About Steve Rhode

Steve Rhode
Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.
  • Bundixlake

    I am in a similar situation, but I have money to pay my credit card bills and still have an emergency fund for other situations so yes.I agree with Steve to save for yourself first and then concentrate on paying the cards.

  • DavidL

    Not to over-do this, but certainly developing an emergency fund should take priority over paying down your credit cards. What size emergency fund?  At this point I would not even consider the 6 months of income that you read alot about. I would shoot for one or two thousand, then begin paying down your debt following the snowball method. Once free of credit card debt, begin a combination of increased savings plus increased paydown (that is, above the minimum) of remaining interest-bearing debt (car;mortgage, etc.)

    • http://GetOutOfDebt.org Steve Rhode

      It seems we are all on the same page with the emergency fund but I don’t want to gloss over my other suggestion. If you are getting big tax refunds you are overwithholding and people are cutting themselves short month-to-month when they need it most to pay down bills.

  • http://www.moneyinfant.com/ Money Infant

    I have to agree 100% as well, replenish the emergency savings for sure.  Maybe you could do both, put $1500 into emergency savings and plunk the other $1000 down on the credit card?

  • http://twitter.com/DebtChronicles Travis Pizel

    As a person digging myself out of credit card debt, I agree with Steve’s advice completely.   Every reputable debt repayment plan that I’ve seen states the importance of an emergency fund – some even say to ignore your debt until you have one. 

    Knowing that you have the cash to handle an unexpected expense (and not rely on credit) is a great feeling and an important step to breaking the cycle of using credit cards. 

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