How to use your tax refund to reduce your debt. Many people think by using tax refunds to pay down debt is the best thing to do. This may not be the best way to use a tax refund.
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Hello, I'm your host, Mr. Chuck, a retired accountant turn truck driver, I reduce my debt in a relatively short period of time, that reduction to achieve financial freedom takes commitment, confidence, determination, tax refund, if you're looking for the status of your federal or state tax refund, he should go to irs.gov, or your State Department of Taxation to check the status, how to use your tax refund to reduce your debt. Many people think by using tax refunds to pay down debt is the best thing to do. This may not be the best way to use a tax refund. People who are successful financially tried to reduce the risk and everything they do. They try to minimize the risk that they take for the amount of the money that they're putting up. Whether it's investing in a business or starting a business, or buying stocks and bonds in the stock market, they do their homework, they do research, and they look for things that are less risky when they that give them the best return. So how does that go with your tax refund and pan off debt? I'm gonna go through three different scenarios. Because there's really not a good answer on whether you should use your tax refund to reduce your debt. And it depends on where you are, how much debt you have. And do you have an emergency fund to minimize your risk? And what risk am I talking about when we're talking about paying off debt? What if you use all that money to pay off one credit card? All right, you're doing good. You making progress? Yes, that's a good thing. I don't dispute that. But what are you gonna do, if three weeks later, your car breaks down, you're going to use that credit card to fix the car, you're going to use that credit card to do whatever happened. That was not a good thing. That's why you are better off investing in a emergency fund. What is an emergency fund? An emergency fund is nothing but a savings account that you set aside money that you make sure that you have a minimum amount in there at all times. In case something bad happens, whether your child breaks an arm or leg or your car breaks down, or your hot water heater goes out or your furnace goes out, you have at least some of the money to help pay for that emergency. That's the idea of having an emergency fund. That way you're not creating more debt. In order to get through life, get through whatever life throws at you. That is the reason. So if you're somebody who has two or more credit cards with a very high balance anything over four or 5000 each, and you got a home mortgage, maybe a line of credit, maybe one or two car loans. Even maybe a payday loan, then if you do not have an a savings account, if you don't have a an emergency fund. If you get a substantial amount of money from a tax refund, the best thing you can do to minimize your risk going forward because it's too late to do anything from the past would be to put that money 100% of that money into a savings account. I know they don't pay a whole lot of money but you're not putting in a savings account to make money off of it. You're putting it there. So it's liquid, easy to get to. To use. In case something bad happens. Could be the battery in your car goes bad. Could be a blow a tire on your car. Be anything could be a medical issue with one of your children or yourself For your spouse, but if you have the money, least part of a set aside, you can rest assure that you're not going to create more debt, maybe a little bit more, but not a whole lot more. Also, if you got everything maxed out, and you pay off one credit card, let's say you got multiple credit cards, maybe you've been making the payments late, occasionally throughout the last year or two, and you pay that credit card down, or even get it to a zero balance, you're running the wrist that that card holder, that company that has the card might reduce your credit limit down. So you'll have less credit, which gonna hurt your credit score even more. So what do you do? Well, if you take the refund in, you put 100% of it into a savings account. That's the minimum emergency fund. From now forward from that point forward, you debt reduction plan would be the one quit creating new debt, quit using credit cards, quit borrowing money, overall, stop it to make the minimum payment on all your debt on all your credit cards on all your loans. Only make the minimum payment. Three, you set up a budget, you know how much money is coming in how much money is going out. And now you'll be able to determine how much money you can set aside to put in that savings account to build it up maybe another two or $3,000. And then take that money sometime in the future, when you have it saved up and apply it to one of your credit cards or one of your debts, he should be paying off your debt in the order of the highest rate of interest first. And once you get debt paid off, and then the next highest, and so on and so forth. If you're just starting new at doing this, if you have a credit card with a smaller balance, that you're able to get down to zero, you pay that one off first, you do not cancel it, but you keep it and you don't use it, maybe every month, every once a month, every two months. He's charts a small item on it, and you pay it off, and you keep that because that's gonna help your credit rating. So it's just more than getting out of debt, you're gonna increase your credit rating, you're gonna make it easier sometime down the road to borrow money. In the case you need the money, like buying a new car, or maybe refinancing your home. Whatever the case, you're gonna make it easier for the lender to lend you the money. That in a nutshell, it would be the worst case scenario. How do you do a budget? Well, you got to track all your spending. And the best way, the easiest way I found to do that is to have a computer program. I use count about, I put in everything that I comes out of my checking account, every charge I make on all my credit cards. And then once a month, I do a report by category, get the totals and then that becomes my budget. And then once a week, I do a report for that particular month from the beginning of month to the current day by category and I put that in the actual column of my budget. So I can see how I'm doing week to week is any category and my overspending Why am I overspending? Is it something because I had my car broke down and I had to fix something or is that just because I'm spending too much? Maybe it's something seasonal them overspending maybe I'm buying clothes for my children because they're going back to school. If that's the case, whether or not they go to school or not, I don't know. There might be buying more clothes in one particular month and then they do and other months. So as long as you know why the money is going out and you can justify it to yourself in you know your within your limits of your budget. That's important, because the less the more you can get your spending under control. The more money you're gonna have to put in your savings. The more money you have in your savings, the faster you'll be able to take care of that outstanding debt that you have. Okay, now the next scenario is you, maybe you just got started on reducing your debt, you got serious about it, you got yourself a budget, you're tracking it, you think you're doing good. And you've been doing it for three or four months, you made some progress, and you get your tax refund, and it's a large sum of money. And you just want to speed up paying off your debt. Again, risks versus rewards, what's your reward for paying off your debt? You have one less credit card to pay, that may be good. What's the risk as something bad would happen in the near future in the next six months? He won't maybe not have the money to pay for it? And what are you gonna do? You're gonna create new debt? What's your debt plan, quit creating new debt, make the minimum payment, save, increase your emergency fund, until you have two, three or 4000 access in your emergency fund. And why do you want to do that, let's cover that. Let's say your emergency fund is set at $1,500. And you save up and you got 5000 in there. So that gives you 35, let me do the math here real quick. Out 345. Now you'll have $3,500, that you can apply towards your debt, the whole time you're building up your set, your emergency fund is just getting larger and larger. So something would happen, you have the money there to pay for it and quit creating new debt, then once you pay off a credit card, or pay down that $3,500, maybe you pay off one and part of the next one. Now you're back down to $1,500. So you got a little more risk, but not a lot, because you still got an emergency fund, then you build it back up again, the more you build up that emergency fund, the less risk you have of creating more debt. So the better off you're gonna be. And as time goes on, that emergency fund is going to build up faster and faster, because you have less and less debt to pay on your minimum payments are going to start disappearing. And that means you'll be able to pull more money into your emergency fund into your savings account. And it will build up faster and faster. Even if you're making the same amount of money. And a build up faster if you cut out all your excess spending. If you have a budget, you keep track of what yours I'm not talking about just like not doing things and scrimping as much as you can, you can do that. But I'm not talking about that I'm talking about just get your spending under control. Only buy the things you need. Don't buy the things you want. For now, you got to build up your finances, before you start spending the money on things you want, like that expensive automobile, or maybe that luxury boat, you're thinking about buying. Gotta wait. Too much debt is never a good thing. We can go in much more detail on budgeting. And I'll probably do that here in the next episode. And what percentages of your income each category should be. And I'm going to cover that again. Because it's important to know if you know this stuff off the top of your head, then you can look at your budget, you know, okay, that housing category, I'm in good shape. In fact, I'm in great shape because it's way below the percentage that we that the Max has should be. My transportation is in good shape, my clothing, my food, my entertainment, we're doing good, we're not overspending. He just got to be aware of the amount of money that you have, versus the amount of expenses that you have. So the second scenario where you got things under control, your tax refund should be around 50% of it should you should increase your emergency fund using 50% of your refund. And that should be the new minimum and your emergency fund. Another 25% of it. You can then apply to your debt and use 25% Of the remaining to buy something that you want or need. Let's stick with needs for now. Maybe you need a new refrigerator for your home because your one you have is still working but not quite cold enough. And you could go out anytime. While if you can use part of that refund the buy something like that a new refrigerator, something that you're gonna need sooner or later, or a new washing machine or a new dryer, something that you need. And you use on a regular basis, that necessary something that you really want. Maybe you want a new refrigerator, but don't buy that $5,000 refrigerator, buy that $2,500 refrigerator and do it without creating more debt. And if you stick with this, you'll be much better off. And then the third scenario is you have significant emergency fund, you have enough to pay three months worth of your expenses, you have little or no debt, if your debts gonna be paid off in the next six to 12 months. So everything's under control, you're making progress, then use 25% of it to increase your mergency fund because you never can have too much. Use 25% of it, to pay off debt, and then use 50% of it to get what you need. Maybe he can use it for a down payment on a new used car, whatever. But that's the general idea of what we should be doing. We're building up equity, we're trying to reduce our debt, so that we have more wealth over all. So depending where you are, if you're just getting started and you're surrounding your smothered in debt, or you got it somewhat under control, but you're just starting to get out of debt, or you've had it under control for the last year and a half, two years, and you're making great progress, then you can reward yourself. But here's an article from the balance. Seven Ways to spend your tax refund that you should avoid. Do not spend your refund on nice seven items, unneeded material things that would be once what things that you want. When you have a large sum of money coming in, it could be tempting and splurge on a television gaming system or clothing. But these aren't a good investment. They don't have a lasting positive financial impact. Putting this simply splurging this way is a effectively blunt a lot of money on material items that won't improve your financial situation. To casinos, you may be tempted to take your tax return your local casino, since it's money you didn't expect to have it could be easily to justify gambling, for a chance to win even more money, don't do it. Checking account the posit, a lot of times our refund is deposited directly into our checking account. But if you already got your bills paid off for the month, if you leave it in the checking account, you're gonna be more tempted to go out to dinner, maybe or buy something you don't really need. Because you know, you have the extra money and your checking account. Don't buy a new vehicle that isn't a necessity. If your car's broken down and you absolutely need a new car, then you can use that refund for a down payment on a new one. Or as I would say, a new used car, get a car that's coming off a two or three year lease. I think the leases are mostly three years now. You can save a bunch of money and still get a fairly nice car with 30 to 40,000 miles on it. And you'd be able to run it for 10 years and you didn't pay as much for it. Avoid the of refund advanced loans that some tax practitioners offer because they have interest rates that are fairly high and they have fees and paying off credit cards that you'll max out again, don't pay off a credit card if you just got to go back and use it because you don't have a plan. You need to have a plan. You need to have a debt reduction plan and you need to use your refund wisely. And now go hog wild on doing a vacation because you shouldn't be taking expensive vacations until you're financially stable which If you have investments build up, you have some money coming in from those investments, and you can afford it. And you're not worried about paying the bills, even if you're unemployed. That's from the balance, I got links my show notes. For that particular article, articles from CNBC here are some smart things to do is your tax refund. So we're not telling you to avoid things, but here's what you should be using your tax refund, well invest in your retirement plan, if you don't have retirement plan out work, then you could put some of that money into an IRA. And which would mean you could get another decent refund next year, can use it to pay down debt, build an emergency fund, invest in yourself. That's kind of what I talked about. Recharge for that refund, a golf trip a night out rvn with the family. I'm not too keen. If you got a lot of debt, he shouldn't be doing the recharged with the refund, you should be focused on getting your debt under control, because that's the most important thing to do. Right now, this part of your life. I'll be back in one moment was my final thoughts. If you find this podcast helpful, please rate and review on your app. If you know anybody that may benefit from listening to this podcast, please refer them and I really appreciate it. If you're interested in getting my spreadsheet for a monthly budget, at Facebook, reduced that increase wealth.com Send me an instant message given me your email address, and I will email you my spreadsheet. Everything in your financial life has risks and returns, your goal is to minimize the risk and maximize the return by having an emergency fund here at less risk of creating more debt. And that will max my maximize the amount of money you make, the less debt you have, the less interest you're gonna pay, the less money is going to be tied up making those monthly payments, you're gonna have more money available to just do the things you want to do. I know it sounds crazy. And it seems like it might be an impossible task to get out of debt. But if you're getting a large refund, more than $2,000, and you get that every year, I would be questioning if you're paying somebody to do your tax return. Why are you getting such a large refund, you could be better off using that money every month, every pay, instead of giving it to Uncle Sam to hold for you. You can be getting more money. For example, if you get a $2,400 refund, that's $200 a month that you not have to use. What can you do with $2,400 a month, you can increase your emergency fund faster, you'll be able to pay off debt faster, you just have more money available to get yourself out of the predicament to problem that you've credit for yourself by getting so deep in debt. If you use a tax repair that advertised we give you the biggest refund possible. I'm just saying beware. I used to be an accountant. I used to tell my clients, you don't want to give more than $400 Back in tax refund in any one year. Because if you do, that means you're paying and way too much. And that's money that you should be using every month that you could have, whether it's increasing your retirement savings, whether it's increasing your emergency fund, whether it's increasing your child's college education fund, you'll have the money faster, sooner, and you'll be much better off. So be aware if they promote big refunds because when secret they're not doing anything else that any other tax repair is doing. The only thing they're doing is adjusting your withholding. If they give you a W four and say take this to your employer, they're adjusting your withholding so you're paying and more in taxes so they get a bigger refund. If you're getting a bigger return Fun. You make sure they explain that W four to you. Why are they increase in your withholding? A should be decrease in your withholding. Your goal is to not pay in as much money. Your goal would be to get about a $500 refund from the Federal every year or less best if you owe about $50 Because that means you didn't overpay. So is everything is stable in your life, you got the same amount of income and your children still fall in that category for the child care, credit and all those other factors. Tell them you want your withholdings to be reduced so that you get your money every pay instead of once a year. You're not working to give your money to the government. You're working to improve your life so that you can live a better life. Adjust your withholdings down for those of you who get a large refund. If you're self employed well, you're going to be paying in taxes because you're going to be paying you pay in lot more taxes. So don't overpay only pay in the minimum amount you need to pay in so that you are in good graces with the IRS and your State Department taxation. So review your withholdings, adjust them as necessary upper down and make sure you're not overpaying and you'll be glad you did.