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The Do's and Don'ts Of Your 2021 Tax Refund | Prof. Stacy, The Money Teacher

The Do’s and Don’ts Of Your 2021 Tax Refund

So, you have filed your 2021 tax return and you are receiving a tax refund! Yeah!

While that is great news, given the current unstable economic climate, families should carefully consider their spending priorities in light of their individual financial risks. Increasing inflation, the continuing war in Ukraine, and rising interest rates all suggest that a more conservative financial approach would be wise this year. Therefore, the Do’s and Don’ts below reflect an overall focus on stabilizing a family’s financial position; prioritizing, saving, and investing in the future versus current consumption.

According to Kiplinger, the average 2021 federal income tax refund so far is just over $3,300.

DO have a plan for your tax refund.

DON’T let it disappear and leave you wondering where it went.

Intaxication: That nice feeling you get when you receive a tax refund until you realize it was your own money in the first place.

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Do:

Do fund your emergency fund.

If the pandemic reminded us of anything, it was the basic need for an emergency fund. Money may not be able to make you happy, but having an emergency fund definitely can give you breathing room when the unexpected strikes! How much should your emergency fund be? Start with $1,000 as fast as you can save it up; then work towards a fully-funded emergency fund of 3-6 months of expenses.

Do pay off debt.

If you just received a tax return and have your $1,000 starting-emergency fund, then use your refund to pay off your debt. Use the “Debt Snowball” and pay off the smallest debts first … or use the “Debt Avalanche” and pay off the highest interest rate first. Don’t overthink it. Pick a debt and pay it off – or pay it down.

Do make major repairs or replacements.

If you have a leaky roof, unreliable car, or less-than-cold refrigerator, your tax refund may be best used repairing or replacing something before it becomes an emergency … and you need to use your emergency fund. 

Do add to savings.

If you have your starter-emergency fund and have paid off your debt, then you are ready to save! Saving can look different based on your season of life.

Just starting out?

You may want to save for an independent living situation. You’ll typically need to provide three months’ rent when you sign a lease: the first month’s rent, the last month’s rent, and one month’s security deposit.

Already on your own?

Then, the next step for you might be saving for a house. If that’s you, according to the National Association of Realtors’ 2021 Home Buyer and Seller Generational Trends Report (page 84), the median down payment for new home purchases was 12% for all buyers and about 10% for buyers younger than 55 years old. That level of a down payment should allow you to get a competitive interest rate and loan terms. But before buying a home, make sure you have saved your full emergency fund of 3 – 6 months of household expenses – your household expenses in a house, not your apartment.

Maybe you are ready to plan for your kids’ education?

At this stage, you could investigate a 529 College Savings plan. A 529 College Savings plan allows families to save for their children’s post-high school education with tax-advantaged dollars. I’ll soon write a separate post on using 529 plans to save for your children’s education. Regardless of the savings vehicle, this is the stage when you might save for your children’s education.

Do invest in your career.

Maybe you are thinking about participating in the Great Resignation and retraining for a new career or even starting your own business … this is the stage when you could invest in these career shifts.

Don’t:

Don’t splurge-spend on expensive items.

For most Americans, this is not the time for splurging on expensive items such as cars, boats, and expensive vacations. The instability in the economy this year means most people should consider more conservative spending decisions.

Don’t pay off debt before saving a starter emergency fund.

It may be tempting, especially given rising interest rates, to first use your income tax refund to pay off debt. However, this may not be wise as current de-stabilizing economic conditions (inflation) indicate that families should have at least a small amount of savings. Without even just a small emergency fund, the slightest budget hiccup will drive you right back to the credit cards.

Don’t forget an upcoming (financial) commitment.

Do you have a family wedding or graduation coming up? If you have already saved your starter emergency fund, you may want to allocate some of your income tax refund for expenses related to an upcoming event.  

Changes in spending priorities:

Before Covid, most families used their income tax refunds for spending and paying off debt. Last year, most families saved their income tax refunds or used the money to pay down debt. Given the continuing effects of Covid on the economy, increasing inflation, the continuing war in Ukraine, and rising interest rates, spending priorities for your income tax refund in 2022 should probably resemble last year’s priorities more than the years preceding Covid. In a related recent survey from creditcards.com, 47% of Americans stated that they do not plan to increase their summer spending.

Also, don’t forget your state refund, if you get one! Add your state tax refund to your federal tax refund and follow the steps above!

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