It’s tax time again – which for many Americans means that a tax refund is on its way. If you’re going to get a refund this year, how can you use the money to your best advantage?
Of course, it’s always tempting to spend the check from Uncle Sam on something fun. But a tax refund could be sizable – the average amount in 2016 was $2,857, according to the IRS – so putting this money to work could help boost your progress toward your financial goals.
Here are some possibilities for using your refund:
Help fund your IRA
If you were to receive a tax refund of $2,857, you’d have slightly more than half of the $5,500 annual IRA contribution limit for 2017, although, if you are 50 or older, you can contribute an extra $1,000. Consequently, you may find it much easier to fully fund your IRA for the year — and you should do exactly that, because an IRA is a great retirement savings vehicle.
If you have a traditional IRA, your contributions may be fully or partially deductible, depending on your income, while your earnings can grow tax deferred. (Taxes are due upon withdrawal, and withdrawals prior to age 59½ may be subject to a 10% IRS penalty.) With a Roth IRA, your contributions are not deductible, but your earnings are distributed tax-free, provided you don’t start taking withdrawals until you’re 59½ and you’ve had your account at least five years.
Help diversify your portfolio
If a market downturn hits one asset class, and that’s where you keep most of your money, you could take a big hit. Owning an array of investments – such as stocks, bonds, certificates of deposit, and so on – can help prepare your portfolio to weather the effects of market volatility,
By adding new investments, or increasing your holdings of existing investments, you may be able to further diversify your portfolio – and you can use your refund for this purpose. (Keep in mind, though, that diversification, by itself, can’t guarantee profits or protect against loss.)
Contribute to a 529 plan
If you have children or grandchildren whom you’d like to help send to college, consider using your tax refund to help fund a 529 plan. Your 529 plan contributions may be deductible from your state taxes, and your earnings are distributed tax-free, provided they are used for qualified higher education expenses. (However, withdrawals not used for higher education expenses may be subject to both income tax and a 10 percent penalty.)
Pay off some debts
You can help improve your financial picture by reducing your debt load – but it may make sense to prioritize these debts. For example, rather than make an extra mortgage payment, you might want to first tackle those debts or loans that carry a high interest rate and that don’t allow you to deduct interest payments. After all, your monthly mortgage payment will remain the same even if you make an extra payment, but if you can get rid of some smaller debts, you will free up some cash that you could use to invest for your future.
Think carefully about how to use your tax refund. It represents an opportunity that you won’t want to waste.