Your tax refund to work
It’s tax refund season again.
This year, if you’re expecting a check from Uncle Sam, why not put it to work to help you meet your financial goals?
For 2008, the average tax refund was more than $2,700, according to the IRS.
The size of your refund, or whether you will get one at all, depends on your individual circumstances. But if you are going to get a refund, plan ahead for what you’ll do with it.
Here are a few possibilities:
Pay down some debts. If you’re carrying a higher debt load than usual, you may want to use some of your refund to pay down your debts. The lower your debt payments, the better your cash flow and the more money you’ll have to invest for the future.
Build an emergency fund. If you don’t already have an emergency fund containing six to 12 months’ worth of living expenses, you could use your tax refund to start one. Without such a fund, you may find yourself constantly dipping into your long-term investments to pay for unexpected costs, such as a new furnace or an expensive car repair. Keep your emergency fund in a liquid account—one that you don’t draw on for your day-to-day expenses.
Help fund your IRA. In 2010, you can put up to $5,000 into your IRA. Consequently, if you received a $2,700 refund, you’d have more than half of what you needed to fully fund your IRA for the year. (And if you’re 50 or older, you can contribute up to $6,000 per year.) You might not think $2,700 would make much of a difference in the long run. But by investing your refund and giving it years of growth potential, you could end up with a sizable amount.
Consider the following:
If you put $2,700 into your IRA and earned, on average, 7 percent a year for 30 years, you’d end up with about $20,000, even if you never invested another dime.
If you put $2,700 every year into that same IRA, again earning an average 7 percent annual return, you’d end up with more than $270,000 after 30 years. (These examples are hypothetical illustrations and do not represent any currently available investments.)
If you had invested in a traditional IRA, you would eventually have to pay taxes on your earnings, typically when you made withdrawals at retirement. And if you qualified for a Roth IRA, you’d never have to pay taxes on your earnings, as long as you owned your account for at least five years and didn’t start taking withdrawals until you were at least age 59-1/2.
Contribute to a Section 529 plan. If you have children or grandchildren, you may want to establish Section 529 plans to help them pay for college. You can contribute virtually any amount, and your contributions may be tax-deductible if you are participating in your own state’s plan. Plus, your earnings grow tax free, provided the money is used for higher education expenses. (Withdrawals used for expenses other than qualified education expenses may be subject to federal, state and penalty taxes.) Keep in mind, though, that a Section 529 plan could affect a beneficiary’s ability to qualify for financial aid.
You may be tempted to spend your tax refund on things you want today—but, with a little planning, you can use it for things you may need tomorrow.