The average tax refund was $3,218 in 2015. That’s a good chunk of change. Instead of blowing it on new toys or unnecessary spending, consider how you might use your tax refund to invest for retirement. Here are five retirement savings options:
1. The power of compound interest. Investing for retirement is a wise option for your tax refund because compound interest will significantly increase the value of your initial investment over time. For example, let’s assume you invest a $3,000 tax refund, but you don’t add to that contribution. If you earn an annual interest rate of 7 percent and the interest compounds monthly you will have $24,349 in 30 years.
[Read: 5 New Taxes to Watch Out for in Retirement.]
2. Bump up your 401(k) contributions. In most cases you can’t take your lump sum tax refund and put it into your employer’s 401(k) plan, but you could use that extra cash to pay for your current bills and then increase the amount withheld from your paychecks and deposited in a 401(k) plan. For instance, you could use your tax return to pay a particular set of bills, and then increase your monthly 401(k) contribution in an amount equal to those expenses. You’ve effectively shifted your tax refund into your 401(k) plan. You can defer paying income tax on your 401(k) contributions, which could reduce your next tax bill. And if your employer offers a 401(k) match that you haven’t been able to fully take advantage of, increasing your 401(k) contributions is an even better deal.
3. Open an IRA. If you don’t have the option to fund a 401(k) or you would rather put your tax refund directly in a retirement account, consider opening or funding an IRA. You can elect to have part or all of your tax refund directly deposited in an IRA on your tax return, so no additional work is required. If this is your first IRA, be sure to do the math on whether a Roth or traditional option will work better to reduce your lifetime tax bill. You may also need to do some research to find a low-cost IRA with great investment options. IRAs have much smaller contribution limits than 401(k) plans, so take care not to over-fund the account. The 2017 contribution limit is $5,500, with a $1,000 catch-up option if you’re age 50 or older.
[See: How to Reduce Your Tax Bill by Saving for Retirement.]
4. Contribute to a HSA. Another way to get ready for retirement is to prepare for potential health care costs. One way to do this is to fund a health savings account if your health care plan allows for one. A HSA gives you another tax-advantaged way to save, and the money can roll over from year to year and be used for medical expenses at any time. HSA investment options are often limited, and not all health care plans allow for the use of a HSA. But if you have maxed out your other tax-advantaged retirement savings options, a HSA can allow you to bulk up your savings for health care costs.
5. Pay down your high interest debt. While paying down high interest debt isn’t saving for retirement, in can improve your overall financial health. If you’re carrying a credit card balance, you’re paying a high interest rate every single month you carry that debt. That interest is probably costing you more money than you would earn if you put that money into an IRA. So, if you have high interest debts, consider using your tax refund to pay it off. The sooner you pay down high interest debts, the more quickly you can free up cash to save for retirement.
[Read: How to Claim the Retirement Saver’s Credit.]
These are certainly not the only things you can do with your tax refund this year, but they’re among the best options if you want to get compound interest working in your favor and perhaps qualify for a tax break at the same time.
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5 Smart Ways to Use Your Tax Refund for Retirement originally appeared on usnews.com
