If you received a tax refund this year, you may have big ideas on how to spend it. Possibly a well-deserved getaway — somewhere peaceful with no Wi-Fi access sounds nice. So does an upgrade to your home’s outdated appliances — and a little extra fun money to freshen up your closet.
But do you know what lasts much longer than all of those? Compound interest. And this is how you can use it to boost your retirement.
Whether you owe it by way of credit card debt, or enjoy its benefits through investments, you’ve likely experienced the power interest wields over time. That’s why lump sums of cash are so valuable: when invested wisely they make large imprints on your financial future.
So, if you’d like to use your refund to boost your retirement, consider these four approaches. They can add a little extra shine to your golden years.
Pay down high-interest debt
This isn’t an investment in the traditional sense; it’s an investment in you. The interest rate on your credit card is typically higher than your rate of return in the stock market — which means paying that debt down now will actually pay you more long-term.
Max out your Roth IRA
Roth IRAs are an excellent way to stash extra cash and boost your retirement. Because you use money that’s already been taxed, that amount grows tax-free. That means when you’re ready to make withdrawals, you won’t pay compounded tax — instead, you’ll enjoy all of the growth on your original investment.
Roth IRAs also have lighter restrictions than other retirement tools. If you’re under 50 annual contributions are capped at $6,000 annually (2020). If you’re over 50, your annual contribution limit increases to $7,000. One of the primary selling points for Roth IRAs is you can withdraw your contribution amounts for any reason, at any time, penalty free.
Put it in an HSA
We hear it all the time: Max out your 401(k) and other traditional savings vehicles. But rarely does that conversation include your HSA — and if you have a high-deductible health plan (HDHP), it really should.
As healthcare costs rise, your HSA offers excellent tax advantages on medical costs, both now and into the future. For example, funding an HSA through your employer via pre-tax income lowers your overall federal and state tax liabilities. When you invest your refund into your HSA, those funds are tax-deductible — even if you don’t itemize.
Key benefits to investing in an HSA:
- Enjoy tax-free growth in your account balance.
- Take tax-free withdrawals for qualified medical expenses.
- Carry your balance over annually. There’s no “use it or lose it” with an HSA.
- You aren’t required to take HSA withdrawals at certain ages, like with a 401(k) or IRA.
- You 100% own this money, so it follows you, not your employer.
Put it in a traditional IRA to boost your retirement
Individual Retirement Accounts (IRA) come with their own tax benefits — especially if your employer doesn’t offer a 401(k). The main difference between a traditional IRA and a Roth IRA is that the traditional version uses pre-tax funds, meaning you’ll pay some taxes when you make withdrawals. Roth IRAs use post-tax funds, so you don’t pay additional taxes when you start withdrawing money from the account.
So, what exactly is your IRA made of? Think of your IRA as a sushi wrapper; inside you can fill it with all kinds of investments, based on your risk aversion. What are you hungry for? Choose from stocks, bonds, mutual funds, ETFs or other market tools – it’s up to you to select investments that match your appetite.