Do you hear it? It’s the sweet sound of the IRS churning out 50 million tax refund checks. What you don’t hear is the silence of electronic data flying through the ether, zapping another 60 million or so electronic refunds to taxpayers’ bank accounts.
That’s right, nearly 110 million taxpayers will get refunds this spring — nearly four times the number of poor devils who have to pay extra when they file their 1040s. This year’s refunds will average more than $2,300. All told, the government is in the process of returning to taxpayers close to $250 billion. That’s right: A quarter of a trillion dollars is on its way out of Washington and into the pockets of American workers.
If you’re among the happy army of taxpayers getting money back, you face a challenge: What are you going to do with the cash? It’s all too easy to let it get sucked into the maelstrom of the family budget. But you should try to avoid that. To give yourself a fighting chance, decide before you get your refund how you’re going use it.
Pay off high-priced debt. Admittedly, this isn’t as much fun as buying a new handbag or a fancy new TV, but paying off credit card debt could be one of your most profitable moves. Carrying $2,300 of debt on a card charging 18 percent over the next five years will cost you more than $2,000 in interest. Pay off that amount with an average-size tax refund — and take care not to run your balance back up — and that $2,000 will be available to help fill up the car and the pantry.
Shovel it into your IRA. Imagine how putting this year’s tax refund into an IRA could pay off. Let’s say you put $2,300 in a Roth IRA this year and the account earns 10 percent a year until you retire at age 65. If you’re 55, that $2,300 would increase more than two and a half times — to $5,966 — over 10 years. If you’re 45, the account would grow to $15,473 by the time you retire, and if you’re just 25, that $2,300 would grow to $104,096. And, in a Roth IRA, all the money would be tax free in retirement.
Help your kids. Consider using your refund to help your kids get on the right track, by funding their IRA. As long as your son or daughter earned income from a job in 2007, he or she can still contribute to an IRA for 2007, even if the money comes from you. (The deadline is April 15.) And, if your child is at least 18 years old and not a student, Uncle Sam may even effectively kick in some of the cash. The retirement savings credit will rebate up to 50 percent of the first $2,000 an eligible individual puts in an IRA. So, $2,000 into an IRA could instantly cut the depositor’s tax bill by $1,000.
There’s an easy way to avoid the what-to-do-with-my-refund question in the future: make sure you don’t get a refund. You do that by filing a new W-4 form with your employer to put an end to overwithholding from your paycheck. Remember, a refund isn’t a windfall. It’s simply an admission that you paid too much during the year.
Kevin McCormally is the editorial director of Kiplinger’s Personal Finance magazine. Visit kiplinger.com.
— Kevin McCormally
