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5 Smart Uses for Your Tax Refund
Improve your long-term financial situation with the money you get back from Uncle Sam.
By Kimberly Lankford, Contributing Editor, Kiplinger's Personal Finance
March 19, 2009
It looks like I'm going to get a tax refund this year. Should I use the money to pay down my debt, or should I invest it?
In these tough economic times, any extra money you get is particularly helpful. And you're smart to start thinking about what to do with this small windfall before it even arrives -- that way, you'll be less tempted to use it for everyday expenses. Instead, here are five smart uses for your tax refund that can improve your long-term financial situation. And some of our suggestions may surprise you -- these days, there may be better ways to use the money than the two ideas you've considered.
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1. Build your emergency fund. This is the first place you should consider for the extra cash. We've generally recommended that people keep at least three months' worth of essential expenses in a safe and liquid account - such as a money-market account or online savings account -- so you don't land in debt or have to tap retirement funds for unexpected expenses. But now that more people are losing their jobs at the same time that lenders are pulling back on home-equity lines of credit -- which had been many people's emergency fund -- we've bumped up that number to six months' worth of expenses, or up to a years' worth if your job is in jeopardy. (See Build Your Financial Foundation for more about starting an emergency fund.)
2. Pay down high-interest debt. Especially in this economy, you can't afford to spend money on something that gives you nothing in return. That's exactly what high-interest credit-card debt is. Paying down credit-card debt with a rate of 18% is like getting an 18% return -- which certainly looks good these days. When you no longer have to pay interest every month, you'll have more cash to devote to your regular expenses and long-term goals.
3. Rebuild your retirement savings. If you get your refund before April 15, you can still contribute to a Roth IRA for 2008, if you haven't contributed the full $5,000 already (or $6,000 if you're 50 or older), which gives you tax-free money in retirement. If you've already maxed out for '08, consider making your '09 contribution right away. The sooner your money is in the account, the sooner the earnings are tax-free. Sure, you have until April 15, 2010, to make your 2009 Roth contribution. But why wait?
You can invest in a Roth IRA if your adjusted gross income in 2009 is $120,000 or less if single, or $176,000 or less if married filing jointly. If you earn too much money to invest in a Roth, you can contribute to a traditional IRA, then convert it to a Roth in 2010, when the $100,000 income limit for conversions disappears. You'll owe taxes on any earnings when you make the conversion, but the money will grow tax-free in the Roth from that point on. For more, see Why You Need a Roth IRA.
4. Contribute to a 529 college-savings plan. Only after you've covered the first three bases should you consider saving for your children's college, and a 529 is a great way to do it. You may qualify for a state-tax deduction for your contributions, and the money can be used tax-free for college. See our 529 FAQs for more information.
5. Open a Roth IRA for your kids. If your finances are in good shape, then you could use the refund money to help fund your kids' futures. If your children have any earned income -- even if it's just from baby-sitting or a summer job -- then they can contribute to a Roth IRA, up to the amount of their earned income for the year (or $5,000, whichever is lower). And 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. Even though an 8% yield might seem high, given the recent stock-market returns, the long-term return of the stock market is even higher. Despite the devastating 37% loss of Standard & Poor's 500-stock index of large-company stocks in 2008, the average return over the past 82 years -- a period that includes several market downturns, including the Great Depression -- stands at 9.6%.
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Reader Comments (3)
Posted by: Jimbo at 03/21/2009 03:53:09 AM
I agree with everything, but can Kiplinger please stop using the 8% for every investment example. Its becoming to farfetched.... why not tell us about this 8% first...... totally agree about the emergency funds, 6mos is mandatory
Posted by: JD at 03/23/2009 12:45:35 PM
Here's a smart refund use: Buy yourself a pen and use it to fill out a W-4 so you don't get over-withheld next year. Then invest the extra money you get in your paycheck every month at 9.6% for 82 years, and throw the pen cap at the skull of the next idiot you encounter who claims that stocks are a sucker's game invented by the rich and you'll never win by buying and holding for the long-term (because they think 2 years is long-term and they pick the worst 2 years in generations as their example!).
Posted by: patty at 04/10/2009 11:05:41 AM
what about the people who lost their jobs and are not collecting social security or unemployment, what kind of STIMULUS $$$ are we getting??? What about my son in the national guard in florida? do they get anything? he came back from Iraq last year and his company eliminated his job. do the people who defend our country get anything???