Financial Fitness


5 smart ways to invest your tax refund

Posted at 3:47 PM, Apr 02, 2019
and last updated 2019-04-02 15:47:45-04

There’s nothing quite like a shiny new tax refund for sparking ideas about spending. But how about spending it to build your wealth?

After all, it’s often a nice chunk of change. Among the 60% of Americans who had finished their tax returns, refunds are averaging about $2,700, according to NerdWallet’s 2019 Tax Study .

Millennials are the likeliest to get big refunds — $3,013, on average, compared with $2,944 for Generation X and $1,943 for baby boomers — and millennials have the most time to let their money grow. So if you’ve paid off your credit card debt and have a rainy day fund, today could be the day you start on the path to becoming a millionaire.

If your thoughts are running more toward vacation ideas than investing, that’s “totally natural,” says Rob Williams, vice president of financial planning for the Schwab Center for Financial Research. But take a step back. “Don’t let your emotional brain kick in and just say, ‘This is free money.'”

Your tax refund is money that you worked hard for last year. This is “a great opportunity to say, ‘I’m going to take all, or at least a portion, of this and get it invested,'” Williams says.

Here are five smart ways to invest your tax refund for the future:

1. Open an IRA or bulk up the one you have

For investing nerds, there’s nothing quite as sweet as using a tax refund to open up a Roth or traditional IRA. These  retirement accounts offer a slew of benefits , most notably some friendly tax rules:

  • With a Roth IRA, you put money in that you’ve already paid taxes on. But then your money grows entirely tax-free and, if you follow the rules, everything comes out tax-free in retirement. Plus, you can take out your contributions (but not your investment earnings) at any time, without penalty.
  • With a traditional IRA, the big benefit is you put money in before paying taxes on it (if you qualify for that tax deduction). You don’t have to pay taxes until you pull out the money in retirement.
You can have an IRA in addition to a workplace retirement plan, and you can have both a Roth and a traditional IRA. The maximum contribution you can make in 2019 to all of those IRAs combined is $6,000, or $7,000 if you’re 50 or older.

2. Invest in your 401(k)

If you have a workplace retirement plan like a 401(k), that’s almost always a great place to stash some extra cash.

The reason it’s not No. 1 on our list, though, is that you can’t just throw a lump sum like a tax refund at your 401(k). Instead, you’re looking at a two-step process: First, go to your plan’s website to increase your contribution rate, then stash your tax refund in your savings account to cover your expenses once your paycheck gets a bit smaller as a result of your higher savings rate.

3. Use a robo-advisor

The idea of choosing investments can be a bit overwhelming. That’s where  a robo-advisor can help . These online advisors offer a handful of diversified investment portfolios, then use computer algorithms to manage your money at a low cost.

Instead of having to figure out what to invest in, you simply fill out an online questionnaire about your goals and appetite for risk, and the robo-advisor takes the reins from there.

Robo-advisors are bound by the same rules and regulations as any human investment advisor — and their fees are usually a lot lower. On top of that, many robo-advisors offer access to human financial advisors, too.

4. Start investing

Maybe you’re feeling pretty good about your retirement accounts and would rather give straightforward investing a try? It’s incredibly easy to get started these days.

One option is to open an account at an online broker. Many have zero account minimums and a slew of investment choices to pick from, including individual stocks and index mutual funds. Index funds are a low-cost way to invest in hundreds or even thousands of companies through one single investment.

Another way to invest is with an investment app. Some apps will let you buy fractional shares of individual stocks, while others offer ready-made portfolios with a diversified mix of investments.

Plug your numbers into our calculator to see how your savings can grow to $1 million over time:

5. Open a 529 plan for your kid

If you have a tot or two or more, then why not use your tax refund to get a head start on that college tuition bill?

A 529 plan offers tax-free growth on your contributions. When you put your money in, you don’t get a federal tax deduction on that contribution, but you won’t owe taxes on your investment earnings as long as you use the money for qualified education costs. And some states offer state tax deductions for contributing to a 529.

“A tax refund is a great opportunity to say, ‘I could spend that on myself … or I could spend that somewhere where it can grow and fund my child’s education,'” Williams says. “That feels like a pretty good thing to consider.”

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