3 Questions to Ask Before you get Your Tax Refund

A tax refund can be one of the greatest annual influxes of cash for some and nonexistent for others. For those expecting a lump sum in their bank account, here are three questions to ask before it magically disappears. 

Do you have an Emergency Fund?

An emergency fund is a financial safety net for future mishaps and/or unexpected expenses.

Emergency funds should typically have three to six months’ worth of expenses, although the 2020 economic crisis and lockdown has led some experts to suggest up to one year’s worth.

Individuals should keep their emergency funds in accounts that are easily accessible and easily liquidated.

Should you fund your set-back accounts?

A set-back account is money set aside or budgeted for a future expense. Unlike a savings account or emergency fund that has a singular purpose, you can create an account for numerous future expenses such as; a family vacation, home renovation projects, wedding expenses, back to school supplies or Christmas. Essentially, you can create a set-back for any future financial goal or obligation you have.

Should you pay off debts?

Yes, you should always pay off debts! Sorry, that is my gut reaction to the question. However, the question, should you use a tax refund to pay off or down your debt, depends on whether you have this as your top financial goal. In a lot of cases, saving for an emergency fund that can keep you from acquiring more debt is wise. In other instances, if you have a tendency to spend verse save, it might be great to get the money towards a debt reduction goal as quickly possible. 

Before looking into a debt strategy, you should prioritize paying off any overdue debts. Overdue debts can hurt your credit score, cause late fees and—if it’s mortgage payments we’re talking about—even lead to foreclosure.

Once any overdue debts are paid, and you decide to payoff some debts here are the 2 most popular methods to choose which debt mountain to scale first. 

  • Debt snowball: This method has you list your debts in order from the smallest amount to the largest. Starting at the beginning of the list, pay off your debts from smallest to largest (while making minimum payments on all debts).
  • Debt avalanche: This method has you arrange your debts by highest interest rate to lowest. Disregarding the debt amounts, start by paying off the debt that has the highest interest rate (while making minimum payments on all debts) before working your way down the list.

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