Should you pay off debt with your tax refund? • Financial Coach Shannon Clark
What’s the best thing to do with your tax refund? It might seem as if this would be a great opportunity to pay off some debt, but for many family’s that is not the case. Find out the best option for you below.
As Samantha set the phone down on her desk, she nearly bounced over to tell her husband the good news. That was the accountant on the phone, she told him, and they would unexpectedly be getting a tax refund of $3,000.
They’d been struggling to stick to a budget, which made it hard to pay down debt. It seemed as if Sam’s family never saw such a significant influx of money.
As they looked into each other’s eyes, they didn’t even have to say the words out loud to know what they were both thinking…
This was the perfect opportunity to pay off a good chunk of their debt.
But this is only the beginning of their story.
Getting a tax refund or bonus seems like a great way to pay off some debt quickly. However, this turns out not to be the case for many families.
Here’s what we’ll cover in today’s article:
- We’ll talk about how you can prepare now to use any extra income that comes your way to set your family up for the best financial advantage.
- Then, we’ll explore how using your tax refund and other windfalls to pay off debt may not be the best choice—and what to do instead.
How to Windfall Proof Your Budget
While it’s so easy to feel that you’ll never be able to pay off debt, windfalls do come our way at least once in a while.
However, unless you have a clear plan in mind ahead of time for those extra funds, they’ll disappear faster than last night’s macaroni and cheese.
But Shannon, money isn’t just going to start falling from the sky anytime soon
I hear you.
However, I’ve witnessed so many times when it really does.
Once you have a clear goal, you’ll begin to recognize money outside your regular income that can help you achieve it. Here are just a few common examples from my own life and in those of my Budget Breakthrough clients:
Common Financial Windfalls:
- Tax refunds
- Bonuses from work
- Refunds from rental deposits
- Energy rebates
- Everyday shopping rebates
- Refunds from insurance plans
- Payment for jury duty
- Sale of an unneeded vehicle
- Savings you forgot about
- Gifts and other freebies
When you have a goal in place, you’ll be ready to put these to the best use when they come your way.
I began thinking about windfalls lately as my own family has unexpectedly seen quite a few
Our budget, to be honest, has been tighter this year than I’d like because of some huge health care expenses.
Yes, I’m grateful that we’ve learned to manage our finances well over the years, so we now have choices about care for our family, sometimes beyond what insurance will cover.
However, because of those expenses, I didn’t think we’d be able to put anything extra toward our financial goals this year, which drives me kinda crazy.
But then I found myself overwhelmed by all the ways we suddenly had extra funds coming our way last month.
Of course, money was not literally falling from the sky, but we were receiving income out of the norm, and it was helpful all the same.
First, we learned we’d be getting a partial refund on our deposit when we moved out of our rental house. Energy rebates we applied for when we built our new house came through. And our accountant called and said we’d be getting a small refund.
Something similar happened years ago when we were working on paying off debt
Extra funds poured in in ways I ever could have anticipated with our small income.
And every extra dollar we got immediately went toward our goal—before it could get swallowed up in our regular monthly spending.
These small windfalls do happen. However, we only benefited from all this extra cash because we had a specific goal in place that we track at least monthly.
You need to have a goal in place, so you’ll be prepared for when windfalls come your way.
What should you do with your tax refund and other windfalls?
Remember Samantha and her husband?
After they received their refund that year, she immediately sat down to the computer and put an extra payment on their loans.
It felt responsible, like for a moment, they were doing this adulting thing well.
Unfortunately, a year later, they found themselves in the same situation.
Again they were battling the Sisyphean task of paying down debt with their tax return, without ever seeing any sustained progress toward becoming debt free.
It’s been said that doing the same thing again and again while expecting a different result is the very definition of crazy.
And Samantha was stuck in the crazy cycle of debt.
Maybe you’ve found yourself in the same situation.
You’re hopeful that the next tax refund or bonus will be the answer. Of course, these are blessings, but you need to take one crucial step first to really put them to work for your family.
You need to have a baseline savings account before paying extra on your debt
Don’t delude yourself into thinking you’ll be ok with little or no savings.
The problem comes when big expenses pop up that you aren’t ready to cover (think car repairs, hospital bills, a new furnace). And that’s when you fall back into debt.
The progress you made is wiped out, and you end up feeling defeated.
You’re stuck in the debt cycle, and the only way to escape is to build your savings first. This way, you can take care of your home and family when life gets expensive without relying on debt.
Savings is essential on a practical level, but it’s just as important for your money mindset
You need to feel successful to stay motivated.
If you’re forced to use debt again because you didn’t have savings, when you swore you never would again, it’s tough to get back on that horse and keep on riding.
On the other hand, many of my students have followed my advice to save up cash for emergencies first. Then, when their car breaks down, or the stove stops working, they simply dip into savings and keep right on marching toward their goals with a sense of triumph.
Though they aren’t excited about having to pay for the extra expenses, there’s a new sense of pride in them because they were able to do so without relying on debt.
So, if you do you have a windfall coming your way soon, it might actually be wiser to save it instead of paying off debt.
Still, there’s one mistake that you can run into when you’re blessed with some extra moolah.
Lottery winners are notorious for going bankrupt, and it’s no wonder
Just because they’ve suddenly become flush with cash doesn’t mean they have the hard-earned wisdom that comes with learning to manage money well.
We’d all like to think we’d do better if we were in that situation, but the truth is, it’s easy to make the same mistake. (It’s just that we’re usually dealing with thousands rather than millions.)
Interestingly, my clients who begin the Budget Breakthrough program in June often end up making progress faster than those who start in January.
I believe the difference is that those who start off with Christmas bonuses and tax refunds to boost their goals aren’t forced to rely on foundational skills like budgeting as quickly.
If you’re using windfalls alone to help you pay off debt and save for the future, you’re likely to stay stuck.
You may be able to pay off a big chunk of debt come April. However, if you don’t make some essential changes in your financial life, you’ll likely end up next year still trying to pay off that same debt — or even more.
Instead, set yourself up for a lifetime of sound financial stewardship by learning to budget alongside using windfalls to help you make faster progress.
We’ve covered a lot, so let’s review
Getting a tax refund or other windfall is an excellent opportunity to make a big dent in your financial goals but only if you already have a goal in place.
Otherwise, that money will quickly disappear. Though you’re excited at the prospect of becoming debt free, make sure you have a baseline emergency fund in place before you pay extra on your loans.
Sure, saving isn’t as exciting, but it’s absolutely necessary if you want to enjoy freedom from the weight of debt long term.
Finally, don’t allow yourself to rely only on windfalls to pay off debt without learning to consistently stick to a budget as well.
Here’s the good news
Though Samantha was hesitant to take a little longer to start paying off debt, she was tired of using her credit cards as an emergency fund.
So instead, she used their tax return the next year to fill up their savings fund first.
Then she could really enjoying paying extra on their credit card debt, knowing it was never going to come back again. They plan to keep attacking that debt until it’s long gone.
And when the next car repair bill pops up, she’ll able to bounce back quickly without using credit.
What can you do today?
If you, too, are ready to escape the debt cycle, maybe this year, it’s time to try a different approach.
Here are three steps to take:
- First off, if you don’t have a specific financial goal, it’s time to get one. Should you save or are you ready to pay off debt?
- Then, put any extra income that comes your way immediately toward that goal before it gets absorbed into your regular monthly spending. Brainstorm possible windfalls that might be coming up for you this year, so you’ll be ready.
- But don’t only rely on out-of-the-blue blessings to solve your financial struggles. As always, learn to budget the right way for consistent success.
I’ll walk you through all this in my free budgeting quick-start course, so get started now. Send me lesson #1.