Investing Your Tax Refund Will Reap You Rewards For Your Retirement

NEW YORK (MainStreet) — Investing a tax refund toward in a retirement portfolio or paying down debt will help consumers boost their savings.

It doesn't provide the instant gratification of splurging, but it's a long-term strategy: consumers should opt to save or invest their tax refund instead of spending it on items that only depreciate in value.

Start With Your Roth IRA

Allocate the extra money toward your Roth IRA, which is the “single best savings vehicle available to American taxpayers,” said Charles Sizemore, a registered investment advisor with Sizemore Capital in Dallas and a portfolio manager on Covestor, the online investing company. A Roth IRA is one of the best options for Millennials and Gen X-ers, because even though contributions will not reduce their tax liability now, the money grows and comes out tax free later in life when they're likely to be making more money and in a higher tax bracket.

Depending on your income in 2015, you can contribute up to $5,500 or $6,500 if you are 50 or older in a Roth IRA. With the average tax refund yielding $3,000, investors who put that amount toward an IRA or Roth IRA will have reached about half of the annual contribution limit, giving them a head start on their retirement savings for the year.

ReKeithen D. Miller, a certified financial planner for Palisades Hudson Financial Group in Atlanta, recommends investing allocating your Roth IRA money in a low-cost index fund or a target-date retirement fund.

The tax break from a traditional IRA provides fewer benefits for people who make a modest income currently or are just starting out in their careers, putting them in the 15% tax bracket, Sizemore said. 

Build Your Emergency Fund

Fund your rainy day account even if you already have one. Emergencies crop up all the time, whether the battery in your car died or you lost your smartphone again.

The best place to sock it away is in a savings account so it is “liquid,” in case you need it right away. Don’t worry about the low interest rate and how much money you could be making on it.

“This is not an investment, but more like insurance,” said Ben Barzideh, a wealth advisor at Piershale Financial Group in Crystal Lake, Ill. A rainy day fund should come before paying down debt or investing money, because if you lacked emergency money, it would mean that you will most likely go into debt to take care of emergencies that come up, he said.

“Many people are living in the land of very low or non-existent emergency funds and getting an influx of cash is a great way to fix that,” said Scott Halliwell, a financial planner at USAA, a San Antonio-based financial institution. “If you have consumer debt you’re trying to knock down, you might start with a smaller amount like $1,000, just to give you some cushion for the unexpected.”

Of course, if you have already have three to six months of living expenses saved, then putting your tax return into your savings account is “only slightly better than putting the money under your mattress,” since returns are anemic and hovering around 1%, Sizemore said.

“Yes, it's there if you need it, but you're not earning a return,” he said. “A savings account makes sense if you have a specific use for the funds in the near future, such as a house down payment or your kids' tuition payment and you have zero ability to accept short-term losses.”

Consider HSAs

Health savings accounts (or HSAs) are paired with a health insurance plan that has a high deductible, which is $1,300 for an individual or $2,600 for a family in 2015. HSA contributions are not subject to federal income taxes and can be invested like an IRA. The advantage of HSAs is that the unused funds roll over each year and any remaining money can be used for retirement after the age of 65. It can also be used as another way to save money for your retirement since most accounts allow you to invest them in stock mutual funds.

“If you have already maxed out other tax-deferred savings vehicles, such as your company 401(k) plan or a traditional or Roth IRA, maxing out an HSA contribution is the next logical step,” Sizemore said. “That's what I do personally, so I pay most of my medical expenses out of pocket and use the HSA account as an ‘extra’ IRA savings vehicle.”

Kill Debt

Too many consumers often make the mistake of saving their refund rather than paying down their debt, such as student loans. In fact, consumers will save more by “knocking down high-interest debt,” in the 6% to 8% range, said William Waldner, a New York-based personal finance expert and personal bankruptcy lawyer.

The extra money should be used to pay down credit card debt since the average interest rate on balances is 13%, and skews even higher. Consumers are getting a “return” on their money in the teens by just saving the cost of paying the interest, said John Petosa, a professor of accounting at Syracuse University.

Refi

A typical tax refund will likely cover the cost of refinancing your high interest mortgage, said Kevin Gallegos, vice president of the Phoenix operations for Freedom Financial Network, a consumer debt resolution company.

“If your credit is good enough to refinance, you could save thousands more in interest charges over the life of the mortgage,” he said.

Get Insurance

If you are lacking enough insurance coverage, buy more for yourself or your spouse such as life or disability insurance, Barzideh recommends. Or increase your home insurance if you don’t have adequate coverage.

Many people rely too heavily on insurance provided by employers, which will not last if you leave the job, said Jeremy Hallett, CEO of Quotacy, a Minneapolis-based online life insurance company.

“We recommend life insurance policies that are ten times your annual income, plus any major debts like mortgages,” he said. “A 35-year old can get a $500,000 20-year term policy for less than $300 per year.”

Be Bullish on Yourself

Investing is yourself can improve your health - get a gym membership, buy better quality food or take additional courses on subjects that interest you or can help your career, so you can "recharge your batteries and build some memories," Barzideh said.

Donate

If you don’t need the refund, then use the money to help others who are less fortunate with a portion of your money, even if it is just a small portion, said Barzideh.

“Besides the fact that it’s just a nice thing to do, scientific studies show people who are more giving actually live longer and happier lives and are more financially successful in life compared to those who don’t give,” he said.

--Written by Ellen Chang for MainStreet

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