Too many Americans have a bad habit of using their tax refund to splurge on a big purchase, like a new TV or a shopping spree at the mall.
The problem is that too many of us look at a tax refund as “extra money,” when in reality it’s money we have worked hard for all year long, just like the money in your paycheck. Instead of spending your refund right away this year, here are three smart ways to put your tax refund to work for you.
Are you saving enough for retirement?
Your tax refund can be an easy and effective way to save for retirement. And, since it feels like “extra money,” you probably won’t even miss it.
Consider opening an IRA with your tax return this year. You have two types to choose from — traditional or Roth. Both are similar in that you can contribute up to $5,500 in 2015 ($6,500 if you’re over 50) and your investments will compound on a tax-deferred basis while in the account, so you won’t pay dividend or capital gains taxes each year.
The main difference is the tax treatment of your contributions. The money you contribute to a traditional IRA might be deductible on your 2015 taxes, depending on your income level and whether or not you have a retirement plan at work.
With a Roth IRA, your contributions are not tax deductible. However, any qualifying withdrawals are completely tax-free. And, with a Roth IRA, you are free to withdraw your contributions (but not any investment gains) at any time. There are income limits to qualify to open a Roth IRA, so make sure you choose the best account type for your situation.
Educate your kids
Another good use of your tax refund is to contribute to a tax-advantaged account to save money for your child’s education, or to start one if you haven’t already. Over the long run, your contributions can really build up.
There are two main varieties to choose from — 529 plans and Education Savings Accounts (ESAs).
529 plans are administered by the states and allow for contributions up to the total cost of your child’s education. Specific minimums and maximums can be established by the states, and be aware that contributions of over $14,000 in a single year can be subject to gift tax consequences. Investments are generally restricted to a basket of mutual funds, similar to most 401(k) plans. And, the money must be used for a qualifying higher education expense, such as tuition, fees, or books.
Do some projects around the house
If you want more of an “instant gratification” method of using your tax refund while still spending the money wisely, home improvement projects can be a good way to go.
Now, when I say “home improvement,” I’m referring to anything that enhances the value (or functionality) of your home. For example, using your tax refund toward updating one of your bathrooms is a good use, because bathroom renovations are a great way to improve your home’s value.
In fact, experts say you can expect to recoup 62% of the cost of the project when you sell. And in the meantime, you’ll have a nice new bathroom to use.
On the other hand, when I talk about home improvements, I don’t mean buying a new TV, putting a trampoline in your backyard, or pretty much anything else that could be classified as putting “stuff” in your home.
Your refund can go a long way
Before you go out and spend your refund, consider this. A new top-of-the line smart TV might cost you about $2,000.
However, if you invest that money for your future instead and earn 8% annual returns (a very reasonable estimate — less than the S&P’s historical average), it could be worth more than $20,000 in 30 years.
Which would you rather have — a new TV, which will actually lose value as time goes on, or more financial freedom later in life?