Some consumers might find it tempting to purchase an expensive item or book a vacation with their tax refund, but experts recommend paying down debt or investing their tax dollars in an IRA.
Investing your hard-earned money now will generate a large amount of savings over several decades.
Socking away the refund in an IRA or health savings account (HSA) means you can keep more of your money instead of giving it to Uncle Sam.
Even if you only save or invest half of your tax refund each year, you will accumulate a decent amount by the time you retire.
Here are five options or investments to consider putting the money from your tax refund in.
5 Smart Ways to Invest Your IRS Refund
1. Pay Down Debt
Consumers who are saddled with debt such as credit cards, student loans or personal loans could use all or a portion of their tax refund to make extra payments towards their loans.
“A tax refund is often the biggest windfall most households see all year and represents a great opportunity to make financial headway and positively impact your future,” said Greg McBride, chief financial analyst at Bankrate, a New York-based financial data company.
Paying off your credit card debt represents a sizable guaranteed return since credit card rates typically range from 17% to 25% depending on your credit score, said Ted Rossman, an analyst at CreditCards.com, an Austin-based credit data company.
Some consumers are even paying around 30% if they use store cards, have a low credit score or have paid late and triggered a penalty APR, he said.
“Dedicating your tax refund to paying down this high-interest debt is an excellent choice, Rossman said.
2. Save for an Emergency
If your rainy day fund for emergencies is low because you had to raid it to pay for a car or house repair, your tax refund is a good opportunity to replenish it.
“Boost your emergency savings,” McBride said. “A direct deposit into an online savings account yielding 2% won’t grow to some fabulous sum, but it will shield you from that 17% credit card debt the next time an unplanned expense arises.”
3. Contribute to an IRA or HSA
Many people are woefully behind on their retirement savings. Allocate all or a portion of your tax refund into your IRA to ramp up your savings and pay less money to the IRS. Open an HSA if you don’t already have one since the contributions you make are not subject to federal income taxes. HSAs allow you to put money away for routine and emergency medical expenses. An HSA operates like an IRA and unused funds roll over each year and the remaining funds can be used for retirement after the age of 65.
“Make an IRA contribution for you and, if applicable, your spouse,” McBride said. “A $2,500 tax refund that is contributed to an IRA will grow to over $14,000 in the next 30 years assuming an average annual return of 6%. Nothing fancier than a target date retirement fund or total stock market index fund is necessary.”
4. Invest in an ETF
A refund is an opportunity for people to take advantage of growing their savings or retirement account. Broadly diversified ETFs are often a safe bet since ETFs include thousands of stocks, lowering volatility and risk compared to individual stocks. These investments are passive and have low expense ratios, which means the fees don’t eat into your returns.
Some ETFs to consider are the Avantis Investor ETFs, said Daren Blonski, managing principal of Sonoma Wealth Advisors. The Avantis ETFs are new to the ETF world and comprised of a “lineup of ETFs looking to provide growth using financial science to target higher expected returns in the market,” he said. “The group running these ETFs recently spun out of Dimensional Fund Advisors and brings a wealth of investing expertise to the already crowded smart-beta ETF market place.”
One ETF to consider is Avantis U.S. Equity ETF (AVUS) - Get Avantis U.S. Equity ETF Report, which invests in a set of U.S. large, medium and small companies, “designed to increase investor returns by overweighting with lower valuation and higher profitability ratios,” Blonksi said. The expense ratio is 0.15%.
“While these ETFs don't have a long history, the team behind them is very seasoned,” he said.
While refunds aren’t typically immense sums of money since the average tax refund issued last year was less than $3,000, an ETF or mutual is better than putting all your eggs in one basket with a couple of stocks, said Mike Loewengart, a vice president of investment strategy at E-TRADE Financial, an Arlington, Virginia-based brokerage company.
ETFs like SPDR S&P 500 ETF Trust (SPY) - Get SPDR S&P 500 ETF Trust Report, Invesco S&P 500 Equal Weight ETF (RSP) - Get Invesco S&P 500 Equal Weight ETF Report or iShares Russell 1000 Growth ETF (IWF) - Get iShares Russell 1000 Growth ETF Report can serve to diversify your portfolio at a lower cost.
“Be aware of the fine print though: ETFs and mutual funds don’t come without fees, so check out the expenses of these funds to make sure you’re putting as much of your money to work in the fund itself, rather than the fee,” Loewengart said.
5. Add Sustainable Investments
Allocating money into sustainable investments remains popular as real assets play a “critical role in creating a sustainable world where society can meet the needs of the present without compromising the ability of future generations to meet theirs,” said Michael Underhill, chief investment officer at Capital Innovations in Pewaukee, Wisconsin.
While the long-term implications of environmental, social and governance (ESG) capital market policies are currently unclear, they are serving as a catalyst for ESG integration, he said.
“Many policies are still under negotiation and the full implications of regulations are still unknown, we see emerging implications for global investors and corporates in the following stocks:
- Suez SA, French utility company (SEV)
- Pentair PLC, UK industrial (PNR) - Get Pentair plc Report
- Xylem, U.S. industrial (XYL) - Get Xylem Inc. Report
- Aqua America, U.S. utility (WTR) - Get Aqua America, Inc. Report
- Siemens Gamesa SA, Spanish industrial (SGRE)
- Veolia Environnement, French utility (VIE)
- AO Smith, U.S. industrial (AOS) - Get A. O. Smith Corporation Report
- Vestas Wind Systems, Denmark industrial (VWS)