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Making the Most of Your Tax Refund

March 14, 2008

As the end of winter approaches, the only thing we look forward to more than spring is our tax refund. Chances are you find yourself now working through the filing process, but you may have already received your refund. Either way, if you’re expecting a refund, now is the best time to think about how to make the most of your cash.

Before getting too excited and using all that extra money on a shopping spree, think about how those extra funds could work for you. For example, if you invest $500 at an 8 percent annual compounded rate of return for 5 years, you’ll then have $735. The same $500, if invested for 10 years at an 8 percent annual compounded rate of return would give you $1,079. Please keep in mind these examples are for illustrative purposes only and do not reflect the performance of any particular investment, but you can see the power of compounding. Aside from just stashing it away, let’s take a look at some ideas of what you can do with that anticipated tax refund check.

Add to your already existing portfolio. This may be a good opportunity to invest in a new stock or increase the diversity of your portfolio by adding stocks from different sectors. Funds from your tax refund could help make your portfolio more rounded.
Pump up your 401(k). If your retirement plan allows, you may be able to increase your contribution rate and use some of the money you receive from your refund to make up for the difference. For example, if you are contributing 3 percent to a plan that allows you to contribute up to 5 percent of your salary, you can increase your contribution percentage while using your refund for your living expenses to cover the larger contribution percentage taken out of your paycheck.
Start an Individual Retirement Account. If you don’t have an IRA already, this may be a good time to open one and begin taking advantage of this valuable savings vehicle. Even if you already have a 401(k), IRAs are still powerful saving tools and they offer some tax advantages as well. If you’re not sure whether you need a traditional IRA or a Roth IRA consider a few of the differences:

With a traditional IRA, the maximum annual contribution for 2008 will actually be going up, to $5,000 of earned income, and your contributions may be tax-deductible. In addition, those over age 50 can make additional contributions — known as “catch up” contributions — of another $1,000, bringing the total allowable contribution for the year to $6,000.

With a Roth IRA, your maximum annual contribution will also be $5,000 of earned income, plus the additional $1,000 for those over 50, but your contribution is not tax-deductible. However, the biggest benefit of a Roth IRA is that you will not pay taxes on earnings when you begin making withdrawals after age 59½ as long as your investments have been in the Roth account for at least five years. In both types of IRAs, withdrawals prior to age 59½ may be subject to a 10 percent IRS penalty. The Roth IRA does not have a mandatory withdrawal age, while with a traditional IRA, you are required to start taking withdrawals at age 70 ½.

If you’re not quite sure about what to do with the money yet, consider placing it in a short-term Certificate of Deposit. A three- or six-month CD may be a good option if you are unsure about how to best use the money. That way, your money will still be earning interest while you analyze your options.

This article was provided by

Douglas Hacker, Financial Advisor
Wachovia Securities, LLC. Member SIPC
636-939-1771
http://www.agedwards.com/fc/douglas.hacker

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