July is the month when most salaried individuals file their income tax returns (ITR). For individuals who do not require audit, the last date for filing ITR is July 31, 2026. Self-employed individuals usually receive their payment after deducting 10% TDS. While filing ITR, they can claim any excess TDS as a refund, after adjusting any tax payable. Over the past few years, the Income Tax Department has upgraded its systems to enable faster processing of ITR and issuance of refunds. Have you already received your income tax refund? If yes, or you are waiting for it, this article will show you how to make the most of your income tax refund.
Making the Most of Income Tax Refund for Financial Planning
Some people consider income tax refunds as a bonus. They usually spend it on the latest gadgets/consumer durables, or plan a vacation or spend it elsewhere. These individuals need to understand that the income tax refund is their own hard-earned money that is being returned to them, and they should use it judiciously.
Spending your income tax refund on the above mentioned things can provide instant gratification. But when used judiciously, it can help you in your financial planning journey and achieve your financial goals faster. You can choose a middle ground by using a small portion of the income tax refund to purchase an item from your wish list and a larger portion to improve your personal finances.
You can use income tax refund to improve your personal finances in the following ways.
1. pay off high cost debt
Do you have any high-cost debt, like credit card dues or personal loans? If yes, use the income tax refund to repay it. Credit cards typically charge interest rates of 3.0% to 3.5% per month on the outstanding balance carried forward. This translates to an interest rate of 36% to 42% per year, making credit cards one of the most expensive forms of credit.
If one has credit card dues as well as a personal loan, the income tax refund can be used to repay the credit card dues first, and the remaining amount, if any, can be used for personal loan prepayment. Repayment of high-cost loans helps to free up cash flow which can be used for investments to achieve financial goals.
2. Build or expand your existing emergency fund
If you don’t have any credit card dues or personal loans, you can use your income tax refund for your emergency fund. An emergency fund comes in handy during events like hospitalization or other medical emergencies, job loss, salary delay, salary cut, etc. An emergency fund should have enough balance to cover 3 to 6 months of expenses.
If you don’t yet have an emergency fund, you can use your income tax refund to create and maintain an emergency fund. If you already have an emergency fund, check whether that amount is sufficient or not. If not, use your income tax refund to boost your emergency fund. The emergency fund amount can be kept in a savings account or a liquid mutual fund.
3. home loan prepayment
For most individuals, a home loan is a long-term commitment of 15 to 20 years or even more. A large part of the monthly income goes towards repaying the home loan EMI. Many people want to repay their home loan before the stipulated time.
In such cases, a lump sum amount, such as income tax refund, annual bonus, quarterly/annual variable salary, or others, can be used to make partial prepayment on the home loan. When you make partial prepayment using income tax refund, you can ask the bank to reduce the EMI or loan tenure.
If EMI is a significant part of your monthly income, you can ask the bank to reduce the EMI. This will free up some cash flow which can be directed to other purposes. If you are comfortable with the EMI, you ask the bank to keep the EMI stable and reduce the loan tenure. This will help you to repay the loan before the stipulated time.
4.Invest towards financial goals
If you don’t have a home loan, you can use your income tax refund to make additional contributions toward your financial goals. These may include creating a fund for the child’s higher education or their own retirement. When investing in equity mutual funds for long-term goals, you should take the SIP route. So, you can deposit the income tax refund lump sum in a debt fund, such as a money market fund or liquid fund. From there, you can do a systematic transfer plan (STP) to transfer small monthly amounts to the equity fund that you are using to fund your child’s higher education or your own retirement.
Investing the income tax refund amount towards financial goals can help you achieve them faster than scheduled. While building a retirement fund, contributing lump sum amount like income tax refund along with regular SIPs will help you accumulate a larger retirement fund than planned.
Some people contribute a lump sum amount every year to the National Pension Scheme (NPS) or Public Provident Fund (PPF). Therefore, income tax refund amount can also be deployed for this purpose. This will help you make your annual investments in these financial products and contribute to achieving your financial goals.
Your Income Tax Refund Can Speed Up Your Financial Planning Journey
Some people get excited after receiving their much-awaited income tax refund. There is a desire to use it to upgrade mobile or tablet for instant gratification. However, instead of spending it on lifestyle, use it to improve your personal finances. If you use income tax refunds and other lump sum cash flows for this, it can speed up your financial planning journey and help you achieve your financial goals sooner than expected.
