Boost Emergency Fund
Bolster your rainy day fund in case you become ill or your car needs a new battery. An emergency fund totaling six months of your expenses should be set aside in a savings account, said Bochese.
“If you don’t have an emergency account or you don’t have enough saved, a large refund can get you closer to this goal,” he said.
Skip the brick-and-mortar banks if you want to beef up your emergency cash. Online banks offer much higher interest rates than traditional banks. Instead of receiving the “paltry 0.01% interest rates offered at many traditional banks, some online banks offer rates that are 100 times higher at 1%,” said ReKeithen Miller, a certified financial planner with Palisades Hudson Financial Group, a Scarsdale, N.Y. company.
Investing in Retirement Account
Increase your retirement savings by investing the refund in an IRA or 401(k), which are both tax free accounts. Since 1950, the average annual return on the S&P 500, a benchmark index, has been over 11%, said Robert Johnson, president of The American College of Financial Services in Bryn Mawr, Pa. In 15 years, a $3,000 initial investment at 11% would generate $14,354.
“In 30 years it would have grown to $68,677 and that is exactly why compound interest has been referred to as the eighth wonder of the world,” he said. “Let's say you found a great investment like Berkshire Hathaway, a company which has had a compound annual return of 19.2% since its inception. That $3,000 would grow to $41,800 in 15 years and in 30 years it would increase to a whopping $582,600.”
Since the average refund yields $3,000, allocating that amount toward an IRA or Roth IRA means an investor will have reached more than half of the contribution limit for the year, which is $5,500. This gives consumers a head start on their retirement savings for 2016.
Socking away the money in a health savings account, or HSA, if you have a health insurance plan that has a high deductible also lowers your taxable income. The contributions are not subject to federal income taxes and can be invested like an IRA. The maximum amount is $3,350 for an individual and the advantage is that the unused funds roll over each year and any remaining money can be used for retirement after the age of 65.
Investing in an IRA or 401(k) helps lower your tax bill for 2016, said Matt Armstrong, a financial advisor for Savant Capital Management, a Rockford, Ill.-based wealth management firm.
Aim to contribute at least 10% of your salary to your 401(k), especially if your employer matches the contributions, said John Jordan, an executive at Bank of America, the Charlotte, N.C.-based financial institution.