The IRS gives tax refunds to many people who overpaid, but most people aren’t sure what to do when they receive that check in the mail.
Frugal living expert Kate Kaden recently received a question from one of her viewers about whether you should save your tax refund or pay off debt.
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While there are personal elements to consider in any financial situation, Kaden offered broad suggestions that can help people assess their finances and determine the right move for their tax refund.
When To Save Your Tax Refund
Kaden suggested having a financial buffer that can cover at least one month of living expenses while highlighting that an emergency fund that can keep up with three to six months of living expenses is even better. These reserves were the decisive factor for Kaden’s analysis.
“If I had neither of those, I would absolutely save a little bit for a cushion,” Kaden said in her video.
If you do not save money, you risk having to take out a loan for any emergency expense. She said that $500 and $1,000 emergency expenses are quite common, so you should have that much set aside at the very minimum.
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When To Pay Off Debt With Your Tax Refund
Her opinion shifts if you already have a financial buffer or an emergency fund. You have enough cash in this scenario to weather short-term emergency expenses and can be more aggressive with paying off debt.
“If you were set up in this way, I would get rid of debt,” Kaden said.
Kaden then said that anyone who is in debt should prioritize high-interest debt, especially credit card debt. Those APRs often start at 18% and can exceed 30% in some scenarios. That type of debt can be financially crippling if you do not address it over a long period of time. While mortgages and personal loans also come with interest payments, they often aren’t as severe as credit card debt.
Getting rid of high-interest debt will make it easier to eliminate other debt since your interest payments will decrease over time. However, it is just as important to determine how you got into debt. Bad financial habits can compound in the long run, and people who are navigating higher expenses may have to pick up a side hustle to make ends meet.
The tax refund can act as a second chance, but if you do not change your financial situation, you will end up in debt all over again.
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This article originally appeared on GOBankingRates.com: Save Your Tax Refund or Pay Off Debt? Frugal Living Expert Kate Kaden Weighs In
