Now that we’re in the midst of tax season, you may be anticipating a tax refund, if you haven’t already received one. Of course, not everyone receives a refund, but, among those who do, the amount can be sizable. In fact, in 2005, the average tax refund was about $2,125. If you’re going to get a refund, start planning now on how to use it. By making the right moves, you can help speed up your progress toward your financial goals.
So, what should you do with your refund? Here are a few ideas:
•Put the money in your IRA. To achieve a comfortable retirement lifestyle, you will need to draw on a variety of financial resources, one of which may be an IRA. In 2006, you can contribute up to $4,000 – or $5,000 if you are 50 or older – to a traditional or Roth IRA. So, if you received a $2,125 refund – last year’s average – you’d be well on your way toward “maxing out” on your IRA contribution. If you think that this amount can’t really make that much of a difference to your long-term savings, consider this hypothetical situation: If you put that $2,125 in an IRA that earned 7 percent a year, and you never invested another dime in your account, your money will still grow to more than $16,000 in 30 years. Not a fortune, to be sure, but nothing to scoff at. And in all likelihood, you would not just make a one-time contribution to an IRA. (At the end of 30 years, you’d have to pay taxes on your earnings, but by then, you may be in a lower tax bracket; even if you’re not, you might be able to spread the tax burden over several years. And if you had invested in a Roth IRA, your earnings will grow tax-free, provided you’ve had your account for at least five years and you don’t begin withdrawals until you are age 59-1/2.) Keep in mind that these rates are hypothetical only and do not reflect the rates of any investment currently available.
•Contribute to a Section 529 plan. Many people contribute to Section 529 plans to save money for their children’s (and grandchildren’s) college education. You can put in large amounts each year to a Section 529 plan, and your earnings will grow tax-free, provided withdrawals are used for qualified higher education expenses.
•Pay down high-rate debt. Short-term interest rates have been rising over the past few months. This could mean that you’ll be paying a higher rate on your credit cards – which probably carried a fairly high rate to begin with. If you use some of your tax refund to whittle down this debt, you’ll be making a wise move, as this debt is typically not tax deductible, and, therefore, of no benefit to you.
•Build up your “rainy day” fund. You might want to use your tax refund to build your emergency fund. Generally speaking, you should set aside six to 12 months’ worth of living expenses to pay for expenses such as car repairs, new appliances and unexpected medical bills.
You can’t always count on a tax refund – but when you get one, make the most out of it. You’ll be glad you did.
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