Tax Refund Debt Payoff Strategies for Smart Taxpayers

The U.S. federal income tax filing deadline is April 18th, and many taxpayers who filed early are already receiving income tax refunds. That makes this the right time for those individuals to make smart moves to get out of debt.

The Internal Revenue Service indicates that 78 percent of U.S. individual taxpayers receive an income tax refund. In 2008, the most recent information available, the average individual refund was nearly $3,000. Many surveys find that about half of U.S. taxpayers who receive an income tax refund spend the money immediately. Others are more prudent and save their refund. But what is the smartest way to use a tax refund?

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Close Down Payday Loans

Few investments beat the rate of return for eliminating debt. For anyone carrying a payday loan, it will be the highest interest-rate debt they have. Often, a debt begins at just $100 to $300, but the interest and fees consumers pay on these loans can run into the triple digits every year. Therefore, if a consumer owes a payday lender, that is usually the No. 1 debt that they should pay off with a tax refund.

Pay Down Credit Cards

Credit cards average an interest rate of about 15 percent or more per year. Therefore, paying off credit card debt is like making an investment that earns that much. The only caveat is that consumers must change their mindsets when they pay off that debt.

If you repay debts, but then go right back into debt again, you wind up at square one. Whether your refund can repay your debt completely, or make a big payment toward a large debt balance, promise yourself that you won't repeat your mistakes. Cut up your credit cards or freeze them in a bowl of water if you don't trust your willpower not to charge. Switch to cash to gain real debt relief.

To pay off debt, people save the most money by first paying the bill with the highest interest rate. But some people are more motivated by eliminating a debt completely. They can use a tax refund to pay off debts, beginning with the smallest balance first.

Sometimes, that sense of satisfaction can really inspire people to keep going to work toward debt freedom.

Build an Emergency Fund

For those without major debt problems, a tax refund is instant savings, and can be used to start - or add to - an emergency fund.

It can feel great to jump-start savings. You can even have your tax refund deposited directly into a savings account. That way, you will not be tempted to spend the refund immediately, and can earmark the funds for emergency purposes.

A small amount of savings can be kept in cash in a safe place, or in a savings account. Larger amounts can be kept in a money market fund, or rolling CDs, so the money earns interest and cannot easily be spent, but can be accessed in an emergency.

Taxpayers should remember that it is always a good idea to build toward an emergency fund that would cover six months' of expenses.

In this ever-changing economy and job market, it is a good idea to be prepared for whatever comes your way.

Insure the Home and Family

Everyone should have health, auto, and home or renters insurance. If dependents rely on breadwinners' income, the heads of the household should look into life insurance. An umbrella policy is a relatively inexpensive way to protect from additional liability. And if the household could not survive without an income, purchase disability coverage. Proper insurance can shield savings, because one trip to the emergency room or one minor accident can easily end up costing thousands or tens of thousands of dollars out of pocket.

Fund the Future

Contribute to retirement savings, whether an individual or Roth IRA, 401(k) or other plan. If the program is tax-deductible, it helps next year's tax picture, too.

Get Educated

Parents can put money toward a college savings plan for a child, or adults can strengthen their own financial future by continuing their education. A $3,000 tax refund would make significant headway toward an associate's degree, for instance. Higher education can return the investment. Associate's degree holders earn 23 percent higher salaries than high school graduates, and those who receive a bachelor's degree earn even more.

Invest in the Home

Homeowners might consider using refunds to cover major or minor maintenance to make sure no bigger (and more expensive) problems arise down the road. In addition, these capital improvements can help build additional equity.

It is not every day that the average individual receives an extra $3,000. In that way, many U.S. taxpayers receive a gift each spring - and the wise person will use that gift to get out of debt and move ahead financially.

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Author Credentials: Ian is the founder and Editor-in-Chief of Disabled World, a leading resource for news and information on disability issues. With a global perspective shaped by years of travel and lived experience, Ian is a committed proponent of the Social Model of Disability-a transformative framework developed by disabled activists in the 1970s that emphasizes dismantling societal barriers rather than focusing solely on individual impairments. His work reflects a deep commitment to disability rights, accessibility, and social inclusion. To learn more about Ian's background, expertise, and accomplishments, visit his full biography.