December 15, 2020
Tax season is not exactly the most fun time of the year, unless you’re really into collecting and organizing your tax documents. (Hey, whatever floats your boat.) If you’re among those who are expecting a tax refund from the government, you may be more raring to file your return.
In 2019, the average tax refund was $2,741, according to the IRS. Hey, that’s no pocket change! Now, there are many ways you could use your tax refund. You could spend it on something that you’ve had your eyes on for a while, pay down debt or put it towards your kids’ college fund.
You might even want to divvy up your refund across those options (spread the love, so to speak).
You could also stash that refund away in your retirement account. Now, you might think this is an obvious, responsible thing to do. But if you’re like many people who receive their refund via direct deposit, it can be easy to overlook it and leave the money sitting in your checking account.
So think of this as a friendly nudge to consider putting those refund dollars to work in your retirement savings account. When it comes to building up your nest egg, every little boost can help in the long run.
Before we get into how you could put your tax refund towards your retirement, check to make sure you don’t need the money to cover any immediate purchases or expenses. Ask yourself if you need to use the refund for something else. For example, perhaps, you’re planning on buying a home or investment property soon, and you would rather use the refund to help build up your cash reserves.
By taking a moment to look at your overall financial picture, it could help you decide how much of the refund to set aside for retirement. And if you’re able to put some or all of your refund towards your nest egg, here are two options.
Putting money regularly into your IRA is a smart way to build up your nest egg. If you decide to stash a portion or your entire refund in your IRA, your contribution could help boost your retirement savings by putting those dollars to work right away.
Just remember that IRAs, both traditional and Roth, have annual maximum contribution limits. For 2020 and 2021, you can sock away up to $6,000 (or $7,000 if you’re age 50 and older) between all of your traditional and Roth accounts. If your refund could help you reach your annual contribution maximum, that’s a serious accomplishment! It could bring you one step closer to your retirement goals – what a great way to treat yourself.
If you’re not already maximizing your 401(k) contributions, your tax refund could be put to use there, too. You might be wondering: Wait, how could I put my tax refund towards my 401(k) when contributions are automatically deducted from my paychecks?
Good question. One potential way is to increase the amount of your automatic contributions (usually done by contacting human resources). When you do this, you’re telling your employer to take more money out of your paycheck for your 401(k). You’re essentially using your tax refund to cover the contribution increase.
On top of this, let’s say your employer offers to match your contributions (usually up to a certain amount). Using your tax refund to hike up your regular contributions might help you snag those matching dollars to supercharge your retirement account.
Good to know: For 2020 and 2021, the maximum contribution limit for 401(k) plans is $19,500 (catch-up contribution limit is $6,500 for employees aged 50 and older).
Learn more: The Importance of Having a 401(k)
One of the potential upsides of saving for retirement with an IRA or a 401(k) is that you might see some tax benefits. If you contribute to a traditional IRA – or 401(k) with pre-tax dollars – you could reduce your tax bill for the year. Plus, your money can typically grow tax-deferred until you withdraw it in retirement. On the other hand, with a Roth IRA, if you contribute after-tax dollars today, your withdrawals in retirement are generally tax-free.
Good to know: Your eligibility to deduct a traditional IRA contribution depends on a number of factors, such as tax-filing status, whether you have a retirement plan through an employer, and your income. Visit the IRS website on IRA deduction limits for more information.
A tax refund may feel like “free money,” but remember, it’s simply what you overpaid in taxes to the federal government.
If you’re getting a refund, think about how you might want to use it. Putting that money towards your retirement, for example, is one smart way to put those dollars to work. Whether you decide to park that money in your IRA or 401(k), your future self will thank you for thinking ahead.
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