How To Spend My Tax Refund? C.L. Haddon Answered

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How should I spend my tax refund?

DFA reader C.L. Haddon asked:

Hi, Matt – I am receiving approximately $1,000 back from taxes this year and want to make the best decision as to how to use it. Should I pay down credit card debt, payoff a small installment loan or put it in savings for an emergency fund? I have a personal loan of $1075 at 18%, a credit card with a balance of $3,500 at 14.99%, a credit card with a $1,000 balance at 0% (until June, 2010), another credit card with $4,500 at 9.99%, and lastly a Sears card with a balance of $650 at 22%. I live on SS and income from a part-time job.  I commonly have some difficulty making ends each month, primarily due to one-time events like medical co-pays, prescription co-pays, auto repairs, etc. I am 65, female, and the sole wage earner. What is the best use of the $1,000 refund?

Always pay yourself first

Hi CL, thank you for your question.

If I were in your situation there would be no question as to what I would do with the $1,000 tax refund – I would start an emergency fund and save the entire amount as a buffer against the “one-time events” you mention.

Here are some other ways you can a turn your financial situation around:

Increase your cash flow

The reason you have credit card debt is because it sounds as if you are living pay-check-to-paycheck.  You need to increase your cash flow.  This does not mean that you have to increase your income (although that is a solid idea if it is possible) instead you may want to focus on decreasing your expenses so you have more money available for savings at the end of each month.

Other ways to increase your cash flow:

  1. Create and live by a written monthly budget
  2. Implement the cash envelope system.

Doing these two things help make my wife and I much more efficient in our spending.  Now we tell our money where to go instead of wondering where it went.

Decrease expenses

After seeing your income sources and your debt amounts I am assuming that a good portion of your cash flow goes toward debt repayment; but are their any expenses you could cut, at least for awhile?

Some possible expenses to cut:

  1. Cable TV – we just plain do not need television, if cutting this helps you get on your feet financially, then cut it.
  2. Cell phone – cut back your plan or consider getting a land line with limited or no long-distance service.
  3. Eating out – we were spending $6,000/year on dining out and have since all but eliminated this expense.
  4. Unnecessary groceries – pop, snacks, etc.  Instead focus on beans and buying in bulk, here are a few ways to save money on groceries.

Pay down debt

Another reason you have no cash flow is because so much of your monthly income is going toward the interest on your debt.  I am willing to bet that your debt stacked up slowly over time as one emergency after another hit your pocketbook when you were without savings.  If you have that $1,000 emergency fund then you have some solid ground to stand on next time something comes up.

Build your savings

Beyond creating your emergency fund you should also continue to fund it each month, even if you can only do so a little at a time.  I have debt too, so I cannot save everything I make.  What I have decided to do is attribute 75% of my available cash flow to debt repayment and 25% toward savings.  This allows me to pay down my debt and save at the same time – I call it the 75/25 method.

What do you think?

Do you think that C.L. should use her $1,000 to start an emergency fund, pay down some of her debt, or toward something else entirely?

If you need personal finance advice… ask Matt Jabs.

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1 Melissa

**coughcough** reFUND **coughcough** not reTURN **coughcough**

2 Matt Jabs

Ah geez… corrected. Thanks!

3 Mrs. Money

I think you gave great advice, Matt. 🙂

4 Rebekah

I’m considering using some of my income tax return to become an investor in a lending club. I would like to get the largest return I can on my little bit of “seed” money. What is the minimum investment amount that would make that a worthwhile option? Do you have any other suggestions for ways to “grow” your money? Thank you!

5 Matt Jabs

That is a great idea Rebekah, LC is about the best I option I know of for solid return on investment right now.

Because the returns will be the same regardless of how much you start with, start with whatever you can… there are no minimums – in fact think you can sign up as an investor without funding the account at all. I only have like $300 in mine right now, but I’m earning 11.47% on it!

Open your account here now and then just fund it when you tax return comes in.

6 Ann

I agree that an emergency fund is priority. But I think, if it was me, I would consider paying off the Sears charge and then using the balance to start an emergency fund. Having one debt paid in full would make me feel a little bit of the weight was off my shoulders and having started an ER would help me to breathe a little easier. Paying off one debt would increase her cash flow & she could consider taking the amount she was paying to Sears and doing the 75/25 split you use (which I think is a great idea).

7 Matt Jabs

That is definitely another solid option Ann. The reason I say stash the entire $1,000 now is because of the frequency of CL’s “surprise expenses” related to co-pays, etc. It sounds like she has a lot of them and I’m afraid if her EF isn’t larger that she would blow through $350 too fast and have to revert to credit cards for emergencies again.

8 FinancialBondage.org

My answer was going to be: why do you have to spend it? Save it.

Also, adjust your W4 form so you get only $100 or less back next year. You can use that money during the year, and not let the govt borrow it all year long interest free. Put that money back into your budget during the year.

http://www.paycheckcity.com/w4/w4instruction.asp

9 Matt Jabs

Solid advice… thank you for adding this.

10 kick debt off

Great advice Matt!
I would say YES save it into an emmergency fund. Everything can start becoming an emmergecy when you do not have this fund to fall back on.

11 Matt Jabs

Precisely why I think covering future emergencies to avoid future credit card debt should be her 1st priority

12 Keith Morris

Go shopping!

Er, I mean, emergency fund. 😉

13 Matt Jabs

Ha ha… if only there were no debt… 😉

14 Anthony

Yes with the emergency fund. That is the best idea!

As for the debt, I would try to consolidate by using Lending Club to see if you could get a better rate.

15 Lakita (PFJourney)

Great advice Matt! I would add that CL save the money somewhere that is not easily accessible. I was just discussing somewhere else that one of the reasons I like ING Direct for savings is because your money is “detached” from your everyday checking account.

I don’t know CL’s saving or spending habits, but saving money is something that has to be learned and then becomes a habit. If someone is not used to saving it may be frivolously spent (I’m speaking from past experience!) So save it somewhere it is most likely to stay.

Also, get that Sears paid off ASAP! That is the lowest balance and highest interest so no matter where you fall in debt payoff strategy I think near everyone would agree that has GOT to GO!

Assuming $20 minimum payments, it would take you 4 years to pay off at the current 22% interest rate and cost an additional $318.52 in interest (according to CNN’s debt reduction planner)

16 Robert Espe

Solid advice, now to prevent a repeat situation:

She mentions a series of “one time events”: “medical co-pays, prescription co-pays, auto repairs, etc.”

Although these aren’t paid monthly, don’t think of them as surprises. Larry Burkett used to say that every month is an “unusual month”. This month medical co-pay, next month the car… you get the idea.

The key is to set aside money for them ahead of time. Save at least $1000 over the course of the year for auto maintenance, no matter how “new” your car is. Your insurance probably has a deductible/out of pocket max for the year. You should keep both in cash, since that is the amount you could spend this year.

17 craig

I am joining a few sports leagues in the spring that I will be putting that money towards.

18 Olivia aka the frugal bohemian

Just some thoughts, I might be reading into this, but I’m thinking of a retired freind of mine in similar straights. It depends on what other resources CF Haddon has. If CF has a normal social security check, it isn’t much. (And SS recepients got no cost of living adjustment this year even though prices have gone up.) CF doesn’t mention a pension. The side job isn’t adequate to cover expenses either that’s why she’s in the hole. Let’s assume she’s already pared down expenses. The $1000 will not be enough to do much of anything. Is she on top of her credit cards (able to pay the minimums)? If not she should knock them down enough so that she can cover them with what she brings in, otherwise the interest will do her in. The option of bringing in more cash is the other side of it. Can she do something outside the box a bit? Does she own a home or can she let out a room? Does she own a car? Is there a way of making these assets work for her? Can she get a roomate? Can she do a side job delivering phone books or census work? My friend ended up letting out a room to another lady who comes to town 2-3 times a week and getting a small secretarial job she could do at home on her computer. It’s enough for her to not worry about how to pay for food and property taxes.

19 kenyantykoon

i vote to pay up the debt. one sleeps easier knowing that you are not in someone else’s pockets especially if that someone is a big faceless heartless corporation

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