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How to Make Your Tax Rebate Go Further

By Kimberly Lankford

February 21, 2008

It looks like I'll be getting a $1,200 rebate check from the government. What is the best thing to do with the money?

The government is giving away money this summer to help stimulate the economy, so Uncle Sam would like you to spend your rebate cash. At the risk of sounding unpatriotic, let me suggest some better ways to use the money to help yourself.

Here are five ways to use the government's check to make a big difference in your financial future -- and stretch your money even further:

1. Boost your retirement savings. If you haven't been able to max out your 401(k), now's the time to do it -- especially if you can get free money from an employer match.

If you get a $1,200 rebate check, you can actually afford to increase your 401(k) contributions by $1,600 if you're in the 25% tax bracket (because your contributions lower your taxable income, investing $1,600 only lowers your take-home pay by $1,200). Invest the $1,600 now, and you'll have an extra $16,000 in your account in 30 years, if your investments earn 8% per year.

You can stretch your money even more with an employer match. If your employer matches 50% of your contributions, you'll actually be investing an extra $2,400 ($1,600 plus $800). That one extra contribution can grow to $24,000 in 30 years -- all from your $1,200 rebate check. See Max Out Your 401(k) for more information.

2. Increase your IRA contributions. If you contribute $1,200 to a Roth IRA now and your investments earn 8% per year, you'll end up with an extra $12,000 in 30 years, which you can access tax-free when you're over age 59½. See Why You Need a Roth IRA for details and to find out if you qualify for a Roth.

3. Pay off high-interest credit-card debt. Using the rebate to pay off a $1,200 balance on a credit card with an 18% interest rate, for example, can save you hundreds of dollars in interest. If, instead, you just made the minimum payment on that debt (4% of the balance each month), it could take more than seven years to pay off the $1,200 balance and cost you $635 in interest.

See How to Get Out of Debt for other strategies to help solve your debt problems.

4. If you've covered all of those bases, think about your kids. Investing $1,200 in a 529 college savings plan for a toddler can grow to more than $4,000 in 16 years, which your child can use tax-free for college. See The Best Way to Save for College for more information about how 529s work and The Best 529 College-Savings Plans for our favorite 529s.

5. If you have teenage kids who work – even just on evenings or weekends -- consider using the money to help them open a Roth IRA. They can contribute only up to the amount of their earned income for the year (or $5,000, whichever is less), but you can give them the money to do it.

If an 18-year-old invests $1,200 now and the investments earn 8% per year, that one contribution can grow to more than $44,000 by the time he's 65 -- an amazing illustration of the power of long-term compounding. For more information, see Can Your Child Open a Roth IRA?

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