What could that money potentially help you to accomplish?
Should your refund be spent? In 2016, more than 109 million tax filers received federal tax refunds, with the average refund at $2,893. What happens to that money?
In most cases, little of the refunded money is saved or invested: last year, more people used their refunds to settle debts or pay for cars or vacations than anything else.
As nearly 80% of Americans end up getting a refund from the IRS each year (including about a third of Americans with incomes above $200,000), it is worthwhile to consider other uses for the lump sum.
Where else could your refund be directed? Putting your refund into a savings or checking account is sensible enough – but with the pathetic interest rates most bank accounts earn today, you may be wondering about alternatives. Here are some other options.
You could effectively put your refund into your workplace retirement plan. Does your employer offer to match your retirement plan contributions? If so, you might want to think about contacting your plan administrator or human resources officer and increasing your elective salary deferrals into the plan this year by the same amount as the refund. With your employer’s match, you just doubled your money! Not to mention the increase in growth for having a larger balance in your retirement account. If you deposit the actual refund dollars in a checking or savings account, you can offset the increase in the amount of salary you defer by distributing the refund dollars from the bank account to yourself. Hopefully, that checking or savings account generates at least some interest on those deposited funds as well.
You could fully fund your IRA(s) with it. If you have not made the maximum allowable IRA contribution for 2016 – $5,500 across all your Roth and traditional IRAs, $6,500 for those 50 or older – you could boost that contribution as an effect of your refund. Another option: use the refund you fully fund your IRA for 2017. Not only does this contribution benefit you in the future, it also lowers your taxable income in the year of contribution, saving you money!
You could tell the IRS to put the money in bonds. In addition to a direct deposit or a check in the mail, the IRS gives taxpayers who receive refunds a third option: the money can be used to purchase U.S. Series I Savings Bonds. Up to $5,000 of refund dollars can be invested this way (in multiples of $50). This option carries the lowest risk of all investments and can be redeemed in 12 months.
You could use those dollars for home improvement. Do you think you will live in your current home for years to come? If so, you could apply your refund to energy-saving home improvements (including HVAC, roof and window upgrades) that could result in lower monthly costs and some nice long-term savings for you. If you make such improvements, you might even be eligible for a federal tax credit of up to $500. Congress extended this credit for property placed in service until Dec 31, 2016, and has a history of retroactively preserving it. This means the credit may be able to be used for property purchased in 2017 as well. Even if that credit sunsets, the Residential Energy Efficient Property Credit is in place through the end of 2021 – a tax credit for up to 30% of the cost of qualifying alternative energy improvements to a primary residence.
You could make an additional mortgage payment or pay property tax. Assuming your home isn’t underwater, you may want to use the refund dollars to reduce mortgage principal. Reducing your principal cuts down on the interest you pay over the life of the loan. Most Mortgages charge at least 80% the principle in interest over the life of the loan!! Paying off your Mortgage early saves you thousands in the long run.
Lastly, think about avoiding a refund altogether. In figurative terms, your federal tax refund amounts to an interest-free loan to Uncle Sam. If you don’t particularly want to make that “loan” again, see if your W-4 can be tweaked to decrease the amount of tax withheld from your paycheck each month, leaving you with more money in your pocket throughout the year.
