It may not be all that much fun to file your taxes, but while you’re working on them, 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. If you were to receive this amount as a refund in 2014, 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. 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 Earnings in a Roth IRA can be withdrawn tax-free, provided you don’t start taking withdrawals until you’re 59-1/2 and you’ve had your account at least five years.
Of course, you have other choices. You could use your tax refund to reduce your debt load, which would free up money to invest for the future. Or you could use the refund to help build an emergency fund, which could help you avoid dipping into long-term investments to pay for short-term needs.
Here’s one other possibility: Use the refund to invest in a tax-advantaged college savings account, such as a 529 plan.
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.
Information provided by Patrick Franke, Financial Advisor, Edward Jones, 3520 Ingersoll Ave., Des Moines, 515-255-9641.