It’s tempting to spend your tax refund, but what other options should you consider?
Should You Spend? Over 80% of those who file a return will receive a refund. The average amount is north of $3,000 dollars. What do the recipients choose to do with that money?
Some of the common choices for those who receive a refund are reducing debt or paying for cars and vacations, according to an H&R Block study. Very little of the money is saved or invested. It may be to your advantage to consider what else you could do with the money.
What Are Your Other Options? While a standard savings account is an option, interest rates are currently very low. This may increase the need to consider additional options.
Should You Fund Your Workplace Retirement Account Such as Your 401(k) or 403(b)? This is a tricky one, but it might work for you. You can’t put the refund into your company retirement account directly since contributions need to come from payroll withholdings, but you can increase your contribution at work and then use the tax refund to offset the lower amount of salary you’ll have coming in as a result throughout the year. You could have this automatically transferred to your checking account from savings, for example.
Should You Fund Your Traditional or Roth IRA? Unlike your company account, you can deposit your refund directly into a traditional or Roth IRA account, but should you? If you’re not already maxing out your account ($5,500 plus an extra $1,000 if 50 years of age or older) you might want to consider doing so. Keep in mind that this limit is for all traditional and Roth accounts combined for the year.
What if you’re not sure if you should make your contribution to a Roth or Traditional account? You may be uncertain which choice is the best for you and believe that you would need a better idea of what your income and taxes would be in order to make an informed decision. Your circumstances (including what type of accounts you currently own) might make you more or less inclined to contribute to one version or the other, but for those who are still uncertain, you can always split your total contribution, part into a traditional account, part into a Roth. Having multiple “pools” of money in retirement can give you the flexibility to pull from whatever source is most advantageous in the future.
Should You Invest in Savings Bonds? In addition to receiving your refund by check or direct deposit, you have the option to invest up to $5,000 of your refund in Series I Savings Bonds. If you’re unfamiliar with Savings Bonds in general, do your research beforehand at www.treasurydirect.gov to see if they may be a fit for you. Like most government debt, Savings Bonds will generally pay lower interest than other options in exchange for the safety they provide. Unlike other types of bonds, Series I (and Series EE for that matter) have an additional advantage related to education. Interest on the bonds will not be taxed if used to pay for education expenses at an eligible institution. This makes Series I bonds a popular choice for parents who are looking for ways to fund their child’s education.
What About Home Improvements? I thought we were looking for options other than spending the money? True, but consider what types of home improvements are available to you. Some may have financial advantages beyond simply increasing the value of your home. Installing energy efficient appliances or upgrading windows may provide substantial savings over time.
Home improvements also increase the cost basis of your home which can reduce the amount due in taxes when you sell your home. Currently, those making a profit on their home sale of greater than $250,000 ($500,000 if married) will pay capital gains tax on the amount above this figure. A home improvement is added to the cost basis of your home, which would reduce the amount considered as profit at sale. Be sure to keep records of the expense for as long as you own the home. This will make the filing of the return for the year in which you sell the property easier to complete and ensure you’re able to justify the increased cost basis.
What About Your Mortgage or Property Taxes? Making extra mortgage payments can reduce your principal and help you pay off your home faster. Before you take this step, consider that mortgage interest rates now are historically low and you may make more elsewhere than you would save in interest. Mortgage interest is also tax deductible (subject to limitations) while the interest on other forms of debt you choose to reduce may not be. Consider the full cost of carrying your mortgage payment after taxes are taken into account before making your decision.