If you're getting money back on your taxes this year, its more
important than ever to put the refund to work for your
long-term goals. That's because many investments have lost
ground in the past year.
While it's easy to see your refund as "found money,"
letting it slip away on impulse purchases could mean missing
out on more meaningful opportunities. It doesn't matter if
you're expecting a few hundred dollars or several
thousand—here are six ways to help make the most of it:
1. Pay down your high interest rate debt
Robert DeHollander, a CERTIFIED FINANCIAL PLANNERTMTM
practitioner from Greenville, S.C., says, "Debt is
dangerous, especially in this job market." His
advice—"kill it." You can certainly start that
process with your tax refund. Whether you've got high-interest
credit card balances, or auto or student loans, the minute you
pay down some of that debt, you're saving money. It's simple:
The less interest you pay to creditors, the more money you
keep in your pocket.
Not only does paying down debt save you interest charges,
it cuts your monthly payments and ultimately improves your
cash flow. That could make it easier to meet your regular
living expenses.
2. Build an emergency fund
In these tough economic times, job layoffs are common
and having an emergency fund is critical. DeHollander suggests
using your tax refund to "build an emergency cash reserve
equal to at least three months' worth of expenses." Keep
this money separate—perhaps in a money market account—from
your regular checking account to avoid tapping it needlessly.
Your emergency fund should be liquid enough for easy access if
you need it, but not too easy to use for discretionary
spending. "This is not a Christmas or vacation account,
but rather a true reserve set aside for emergencies,"
notes DeHollander.
3. Add to your retirement savings
Now's your chance to put more away for retirement.
Use your tax refund to open or contribute to an IRA for 2009.
The annual maximum contribution limit is $5,000, and, if
you're age 50 or older, you can add another $1,000 catch-up
contribution. You need to figure out if you would benefit more
from a traditional IRA, which allows tax-deductible
contributions and tax-deferred growth, or a Roth IRA, which
has nondeductible contributions but lets you withdraw the
money federally income-tax free.
Says Julie Welch, director of tax services for Meara Welch
Browne in Kansas City, Mo., and co-author of 101 Tax
Saving Ideas, "You're more likely to leave
the money alone if you put your tax refund into an IRA as
opposed to your regular bank account. It takes a lot more
effort to dip into an IRA than to write a personal
check." With few exceptions, distributions from
traditional IRAs prior to age 59½ are subject to a 10%
penalty in addition to federal and state taxes.
Another option is to increase your 401(k) or other
workplace savings plan contributions for the year by the
amount of your tax refund. At a minimum, says DeHollander,
"fund your 401(k) up to the company match. This is the
best investment available for most people."
Sure, says financial planning consultant Donald Haas, from
Southfield, Mich., "spending is more fun, but saving
gives you a bigger bang for your buck. That's especially true
for retirement savings vehicles where you can invest for
potential appreciation as well as tax-deferred growth."
4. Save for college
"I like the idea of putting your tax refund in a
529 plan account because no matter how much you invest, at
least you'll get your college fund started," says Welch.
"There are no income restrictions, so anyone can
contribute to a plan, and you can put away large
amounts—some plans' maximums are over $300,000," she
adds. Better still, any earnings on 529 plan investments grow
tax deferred, and, as long as you spend the money for
qualified higher-education expenses, you can withdraw the
money federally tax free.
5. Invest for other goals
Since your tax refund probably isn't part of your
regular budget, this money may provide a chance for you to
dabble with investing. Many mutual funds let you start with
small amounts. And if you've toyed with the idea of investing
in stock funds, maybe now is your opportunity to take a little
more risk. Historically, over long periods of time, stocks
have turned in better performance than other types of
investments. Think about how much further your tax refund
dollars have the potential to grow, if you invest them in a
fund rather than spend them on the hottest electronic gadget.
6. Spend wisely
If you're going to spend your tax refund, make the
most of these dollars. Consider doing much-needed home repairs
or even improvements that could make your home more energy
efficient. "Insulated windows and energy-efficient
furnaces are just a couple of ways to cut winter heating costs
and keep more money in your pocket," says Welch. And, she
adds, "Renovations like adding a bathroom or updating a
kitchen could increase your future resale value."
Alternatively, you could put some money toward overdue car
repairs or buying new tires. That could make your car run more
efficiently, burn less gas, and ultimately save you some
money. Consider "parking" your money in a short-term
certificate of deposit (CD) so you won't be tempted to use it
for something else.
Make next year less taxing
Although many people look forward to getting money
back from the government, a tax refund isn't a windfall. In
fact, you've just been lending your money to the
government—interest free. Large refunds mean you may be
having too much money withheld for taxes from your paycheck.
So you may want to adjust your withholding and keep more of
your paycheck throughout the year to help with regular
expenses.
"Clearly, from a financial planning standpoint,"
says Welch, "it's better to keep more of what you earn
during the year." Still, she acknowledges, "most
people would rather get a refund than write a check at tax
time." And if you do get money back again next year,
consider this: your refund dollars haven't been working to
earn you income during the year. So be sure to make them work
hard once you've got the check in hand.
