6 smart things to do with your tax refund
Most people use their tax refunds for bills or necessities. If you can afford to save your refund, you'll be further ahead. Here are 6 savings tactics.
This post is by Ashlea Ebeling of Forbes.com.
Last year, the average federal tax refund was $2,700. What are you planning to do with yours? "The perception is that people get a refund and buy a high-definition TV, but the reality is that people are using refunds to pay down debt, buy necessities, or save," says Bob Meighan, the lead CPA with Intuit TurboTax’s American Tax And Financial Center.
Only 16% of the customers TurboTax surveyed last year said they used their refunds to splurge on vacations or shopping, while 42% used the money to pay down debt or pay bills. Another 17% used refunds to save, including funding an individual retirement account.
If you’re expecting a refund, here are six ways to save it.
Boost your emergency savings. What if you lose your job, your car needs unexpected repairs or your washing machine breaks? Ideally, you should have three to six months savings set aside in an emergency account.
One way TurboTax presents customers with the opportunity to save is by prompting them to save at least 25% of their refund for emergencies. You can pick whatever percentage you’re comfortable with, and direct the rest of your refund to your checking account. For the amount of your refund you want to earmark to savings, simply request payment of your tax refund to your savings account at your bank by listing the routing number and account number on your tax return.
Add to your investment portfolio. You’re not limited to your basic bank savings account. You can direct your refund into a brokerage account, a cash management account or a mutual fund account (it will go into cash reserves) at your brokerage. Just list the prefix number and account number on your tax return. If your brokerage uses letters in the account number fields, you have to substitute numbers.
Save for college. Direct-deposit options for tax refunds also include 529 College Savings Plans and Coverdell Education Savings Accounts, a competitor to 529 plans resurrected by the American Taxpayer Relief Act in January. Your refund will be deposited according to your investment allocation on file. Bonus: If your state offers tax breaks for contributing to a 529 plan, you’ll pay less in 2013 taxes by choosing this option.
Open an IRA. Only 1% of TurboTax customers planned to use their refunds to fund a traditional or Roth IRA, according to survey results included in The Impact of Tax Refunds on Average U.S. Families. Still, you can contribute up to $5,000 per person to a traditional IRA or a Roth IRA for 2012 up until April 15, 2013 ($6,000 if you’re 50 or older). If you’ve already maxed out your 2012 IRA contributions, get a head start on contributions for 2013. The contribution limits have been raised to $5,500 per person ($6,500 if you’re 50 or older).
And you don’t have to first put your refund in your checking or savings account and then transfer it to fund an IRA; assuming you already have an IRA, you should earmark the refund to go directly into the account. Fidelity says it will treat IRA contributions as if they were intended for 2013 unless customers call the service center to designate the contribution for 2012.
Buy savings bonds. You can buy up to $5,000 of Series I Savings Bonds through Treasury Direct (in multiples of $50), and you’ll get bonds the old-fashioned way, in the mail. The bonds can be issued in your name (you and your spouse if married filing jointly), your name with a co-owner, or in someone else’s name if you want to make a gift. The interest you earn is free of state income tax, and if you use the proceeds for higher education expenses for you or your kids, it’s free of federal income tax, too. If you have a Treasury Direct account already, just list the account number, and you can later go online to buy bonds through your online account.
Jump start 2013 estimated payments. If you have income other than wage income (capital gains, dividends and interest or self-employment income reported on Schedule C , for example), you probably have to file estimated tax payments four times a year. The first estimated payment for 2013 is due April 15th, so just apply your refund to that payment, says Tom Butler, a CPA at Berdon in New York.
Mix and match. IRS Form 8888 allows you to spread your refund among three different accounts, including paper savings bonds (or a paper refund check). If you want your refund deposited in just one account, just list it on your 1040. To get that money working for you as soon as possible, choose direct deposit as it gets you a faster refund.
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