For the last several years, when tax time comes around, I get very excited in anticipation of getting my big tax return. And last year was the best one yet: $4,600 between both federal and state tax returns. And what did my wife and I do with the money? We paid off our credit card bill that we had to charge up for a couple of car-related incidences. We had to pay off our emergency that we had incurred seven months prior.
It was great. No more debt, more cash-flow every month, one less check to write every month for the credit card. But this emotion hid the fact that I wasted a lot of money on interest paid to the credit card company. Why hadn’t I saved money for an emergency fund? Well, my situation is different than most. I have a stay-at-home mom at home with our year-old daughter, so we are a single income family. There aren’t a lot of opportunities to save.
However, in speaking with our accountant during tax time, he pointed something out to me in a way I hadn’t thought of before. With a $4,600 tax return, I had lent the government $4,600 over the course of the year, giving them a 0% loan while I was paying 8% on the money I had to borrow in return. That didn’t seem quite right. So he gave me a spreadsheet that calculates how much in taxes you’ll pay on your paychecks depending on whether you claim married and 0 versus married and 1, 2, 3, or any other number you wanted. I realized that I could claim married and 7 for my paycheck withholdings and still break even on next years taxes. This would give me a lot of money throughout the year that I would put into my 4.5% interest bearing savings account, where I would build my emergency fund.
I decided to claim married and 5. This would give me an extra $190 per month, which I have automatically transferred to a separate savings account I set up and titled, “Tax savings”. Now I can track how much money I will save by avoiding the credit cards if an emergency comes up, and how much interest I will gain by not giving it away to the government on a 0% loan.
If no emergencies pop up this year, I stand to make roughly $40 in interest while still pulling down a $1,000 tax return or so. This way I have the best of both worlds. I’m saving for an emergency fund and I’ll still get a bit of a year-end bonus.
This is far and away the best method I’ve encountered in starting an emergency fund. I hope it works for you!