A tax refund is often the only financial windfall we can rely on each year. While there are plenty of ways to spend an IRS refund, depositing that money into an emergency fund should be your priority, said Jen Smith, co-author of Buy What You Love and CNET Money expert review board member.
We all want an extra boost to buy concert tickets or upgrade our tech, but given the uncertainty of today’s economy, building up our savings is the best way to be prepared.
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“We get anxiety because of what we don’t know,” Smith said. Setting aside your tax refund for the future can give you peace of mind for the rest of the year. Here’s why and how to do it.
Starting an emergency fund with your tax refund
An emergency fund can be your safety net in unexpected situations, like a layoff or an unforeseen bill. Putting your tax refund into a separate savings account and treating it like a contingency reserve can help you avoid spending it.
Most experts recommend having enough funds in your savings to cover three to six months of living expenses. Smith says it doesn’t matter how much you initially deposit, but it’s useful to set a goal of at least $500 or $1,000 to get the ball rolling if you’re a two-income household. Depending on your job situation or personal circumstances, you might feel financially secure setting aside more.
If you already have your refund earmarked for other goals, try setting aside just a portion of your IRS money toward your emergency fund. For instance, if you get a $1,700 refund from your state and federal taxes but you’re carrying high-interest credit card debt, use the bulk of your refund to pay off that debt and make a smaller deposit toward your savings. Then, set a goal to contribute to your emergency account throughout the year if possible.
Where you put your tax refund is important
Smith recommends putting your refund in a high-yield savings account instead of your regular checking account linked to a debit card. Your emergency savings will be out of sight and out of mind when it comes to everyday spending, but the funds are there if you need them.
“It’s much harder to save money if you’re seeing it all the time,” she said.
In a high-yield savings account, you’ll also earn interest on your tax refund, even if it’s the only financial contribution you make all year. While annual percentage yields vary depending on the bank, you’ll still earn more interest than with a traditional savings account that only pays pennies on your balance.
