Every tax season, millions of Americans await their refund check for the “biggest payday of the year.”
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However, personal finance expert Rachel Cruze warned that those thinking of their tax refunds as if it’s “free money” is a mistake that could cost you in the long run.
Why Tax Refunds Aren’t ‘Free Money’
A tax refund is a reimbursement made to a taxpayer for an excess amount paid in taxes to the government. If you get a refund, it means you overpaid your taxes throughout the year.
This can happen if you filled out your Form W-4 from your employer with a higher withholding, or if you overpaid on your quarterly estimated taxes as a freelancer or self-employed worker.
“There’s power getting that cash back,” Cruze said on an episode of “The Big Money Show.” “The refund is not free money.”
So far in 2024, the average refund amount is $3,004, according to the IRS. There are also some changes coming for the 2024 tax filing year that could affect your tax refund amount in 2025.
The IRS adjusted income tax brackets again due to inflation. As a result, as The Motley Fool noted, filers whose salaries haven’t kept pace with inflation may find themselves in a lower income tax bracket compared to last year.
Try This: American Opportunity Tax Credit — What Is It and Who Qualifies?
Adjust Withholdings
Tax refunds may seem like a lifesaver when you’re strapped for cash, but it’s essentially an interest-free loan made to the federal or state government.
“It is your money sitting in Washington, not earning interest,” Cruze said. “Adjust your withholdings because I would rather you get to that zero point where you don’t owe anything, but you’re also not getting a massive refund.”
Pay Off Credit Card Debt
If you are getting a tax refund in 2025, Cruze recommends using it to pay off credit card debt. According to The Motley Fool, the average American household has around $8,871 in credit card debt based on the most recent U.S. credit card debt and household data.
“Credit cards have become the emergency fund for so many people,” Cruze explained. “The best thing you can do, honestly, is just cut up the credit cards. Just not even have that as an option.”
Create an Emergency Fund
And because so many people use credit cards as an emergency fund, Cruze is a big proponent of building an emergency fund.
An emergency fund is a cash reserve that you only use for unplanned expenses or emergencies. How much you should have depends on your lifestyle, monthly costs, income and dependents, but the rule of thumb is to put away at least three to six months’ worth of living expenses.
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This article originally appeared on GOBankingRates.com: Rachel Cruze: Why Your Tax Refund Isn’t ‘Free Money’
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