It may not be all that much fun to file your taxes, but you do get to eagerly anticipate that one big question: Will I or won’t I get a tax refund? If you receive a refund, you’ll have to answer another question: What should I do with it?
Your answer may depend, at least in part, on the size of your refund. In 2013, the average federal tax refund was about $2,650. Of course, your refund may be less than this amount (although it could also be more), but if you were to receive a $2,650 refund this year, what would you do with it?
For one thing, you could put the money into an IRA. In 2014, you can put in up to $5,500 to a traditional or Roth IRA, so your $2,650 would represent nearly half your total yearly contribution (if you’re 50 or older, you can put in up to another $1,000, for a total limit of $6,500). But even if you only put in that $2,650, and you left it alone, it could grow significantly. In fact, after 30 years, your $2,650 would have grown to more than $20,000, assuming no further contributions and a hypothetical 7 percent annual return. And if you were able to put in that same $2,650 every single year for 30 years, again earning the same hypothetical 7 percent annual return, you would end up with almost $268,000. This example is for illustration purposes and does not reflect the performance of any specific investment. Illustration does not include charges and fees that could have a negative affect on the performance.
Keep in mind, though, that you will eventually be taxed on your traditional IRA earnings. Earnings in a Roth IRA can be withdrawn tax-free, provided you don’t start taking withdrawals until you’re 59 1/2 and you’ve had your account at least five years.
While funding your IRA certainly can be beneficial, it’s not the only choice you have for making good use of your tax refund. Here are a few other possibilities:
• Pay off some debts. If you have a large tax refund, you could use the money to retire some debts, or at least cut them down to a more manageable size. And the lower your debt load, the more money you will have available to invest for your future.
• Help build an emergency fund. It’s a good idea to build an emergency fund containing six to 12 months’ worth of living expenses, with the money held in a low-risk, liquid account. Without such a fund, you may be forced to dip into your long-term investments to pay for short-term needs, such as a new furnace, a major car repair or a sizable medical bill. Consequently, you may want to put some, or all, of your tax refund into such a fund.
• Invest in a college savings vehicle. You could use your tax refund to invest in a college savings vehicle, such as a 529 plan. With this plan, your earnings grow tax-free, provided all withdrawals are used for higher education expenses. (Keep in mind, though, that 529 plan distributions not used for qualified expenses may be subject to federal and state income tax and a 10 percent IRS penalty.)
As you can see, you’ve got some good choices for using your tax refund wisely. Consider them carefully, and make the moves that work best for you.
• This article was written by Edward Jones for use by Ahwatukee Foothills Edward Jones Financial Advisor Joseph B. Ortiz, AAMS, CRPS. Reach him at (480) 753-7664 or email@example.com. Accredited Asset Management Specialist and AAMS, Chartered Retirement Plans Specialist and CRPS are registered service marks of the College for Financial Planning.