5 investments for your tax refund
(MoneyWatch) Taxpayers received an average refund of about $3,000 for tax year 2010 and are on pace to get roughly the same amount in 2011. Americans love getting a tax refund. What's not to like about found money? But a refund is really just the return of a year-long, interest-free loan that you extended to your spendthrift Uncle Sam. This year, make sure you keep that money and put it to work. Before you plunk down big bucks on a flat-screen TV or buy new iPads for the entire family, consider the following investment opportunities:
1. Replenish emergency reserves. You should always keep 6-12 months' worth of living expenses in a safe place, like checking, savings or money market accounts. But for one reason or another, you may have dipped into your emergency funds over the course of the year. A government refund check can help replenish the account. With interest rates still at rock-bottom levels, explore CDs and I-bonds to boost the income on your emergency reserves. Check out MoneyWatch blogger Allan Roth's excellent post, "Where to stash your cash," for further investment ideas.
Tax tips for last-minute filers
Would you leave the US for lower taxes?
2. Pay down credit card, consumer, or student loan debt. Your refund is an excellent way to put a dent in outstanding debt. The bonus is that when you pay down debt, you are essentially earning a guaranteed return that is likely MUCH higher than any available investment.
3. Boost retirement contributions. If you have access to an employer-sponsored retirement plan, like a 401(k), a 403(b), or a 457 plan, increase your contribution amount for 2012. With your 2011 refund in the bank, you can absorb the extra money coming out of your paycheck. The 2012 pre-tax contribution limit for employer plans has increased to $17,000, up from $16,500, and the limit for over age 50 catch-up contributions is $5,500.
You can also use that extra money now to fund an IRA or a Roth IRA for the 2012 tax year. The maximum contribution to traditional and Roth IRAs is the smaller of $5,000 ($6,000 if you're age 50 or older) or your taxable compensation for the year. (Note: Even if you have an employer-sponsored plan, you may also qualify for the full annual IRA deduction. Check the IRS website for details.)
4. Fund 529 plans. The cost of college tuition has spiked 300 percent since 1990, so the sooner you can kick-start your college savings, the better. A 529 college savings plan offers an easy way to invest in higher education. The money you deposit in a 529 plan grows tax-free, and withdrawals that are used to pay for college sidestep taxes, too. You can invest up to $13,000 in 2012 without incurring a federal gift tax. Some states also offer state tax benefits, so be sure to research the options at savingforcollege.com.
5. Invest in a non-retirement account. If you have maxed-out your retirement accounts and still have extra money, consider opening a non-retirement investment account with a no-load mutual fund company like Vanguard, T. Rowe Price, and Fidelity or at a discount brokerage firm like Charles Schwab (SCHW) or TD Ameritrade (AMTD). Don't be tempted to purchase actively managed mutual funds: According to research over the 23 years ending in 2009, actively managed funds trailed their benchmarks by an average of one percentage point a year. A separate report from S&P also found that most actively managed funds lagged their respective benchmark indices over the five years through Dec. 31, 2010.
Image courtesy of Flickr user Tax Credits