8 Steps for Investing a Tax Refund


The best use of your tax refund is in the market.

As tax season 2018 nears an end, tax refunds are arriving in millions of mailboxes and bank accounts. Most filers receive their refund within 21 days of filing, according to the IRS, and the average refund, as of March 9, was just over $3,000. “When receiving a surprise lump sum like a tax refund, it’s critical to be thoughtful about what you’re going to do with it,” says Rich Guerrini, chief executive officer of PNC Investments. If you don’t have a plan for using your refund, it may disappear into extra meals out and a new pair of sneakers. Here are eight steps for putting your tax return to better use in the stock market.

Develop the habit of investing

It can be tempting to dismiss your tax refund as too small to invest, but that’s a mistake. Studies find that “the habit of regular saving and investing is almost as important as how much you invest,” says Lule Demmissie, managing director of investment products and retirement at TD Ameritrade. Any sum of money you invest reinforces these habits. “Like everything in life, you want to learn these good habits in non-strained environments,” she says. Surprise windfalls like your tax refund are the perfect opportunity.

Clear the way for future investing.

Sometimes the best investment you can make is improving your financial health. Paying down debt – especially high interest rate debt – is a form of investing. For every dollar you pay off on a credit card charging 15 percent, you’re effectively earning a 15 percent guaranteed return on your money. “If you owe a balance on your credit cards, reduce that debt by putting some or all of your tax refund toward that,” Guerrini says. “Otherwise, you could enter a hamster wheel of paying off the minimum or only a part of the balance and then accruing interest.”

Determine your short- and long-term goals.

Before you can invest, you need to know what you’re investing for. “Your goals can be as tangible as buying a new guitar or as broad as saving for retirement,” Guerrini says. Estimate a dollar figure and time horizon for each goal. This will determine the best investment account and vehicle to use. For near-term goals, look to more stable investments like short-term bonds. If you have more time to invest, you might consider more volatile investments like growth funds. “Regardless, you’ll make smarter choices with your tax refund if you’re cognizant of your goals,” he says.


Put tax-sheltered accounts to work for you.

Don’t let the IRS put its hands on any more of your investment earnings than is necessary; tax-sheltered savings vehicles like a 401(k) or IRA let you keep more dollars in your pocket while shielding investment gains from Uncle Sam. You don’t have to pay taxes on contributions to traditional retirement accounts, and the money is sheltered from taxes until you withdraw. If you’re lucky enough to have an employer-sponsored plan, it’s a great place to put your tax return. “Bonus points if your employer offers a contribution match – that’s free money right there,” Guerrini says. “If you don’t have a retirement plan at work, you can start an IRA” and still get the tax benefits.


Take advantage of the new 529 reforms.

Tax reform expanded the use of 529 plans to save for education. Like retirement accounts, earnings in 529s are not subject to federal tax and generally not to state tax when used for qualified education expenses. Thanks to the tax reform bill, the list of these qualified expenses is longer. “You can now use the funds in the account for grade school, high school and college expenses,” Guerrini says. Anyone can establish a 529 for a beneficiary. Contributions to 529 plans are not tax-deductible and may be subject to gift tax if they exceed $14,000 for the year.


Use online screeners to select investments.

You can use stock, exchange-traded fund or mutual fund screeners such as the ones online at U.S. News & World Report to find the right investment vehicle. Screeners let you search for specific ticker symbols or names, or you can browse by category, such as large growth or short-term bond. You can narrow the results by expenses or total return. “The screener will help you understand minimum investments for that instrument,” Demmissie says. For stocks and ETFs, that minimum is the share price. To find the minimum investment for a mutual fund, click on the fund’s name and look under Costs & Fees.


Find lower minimum investments with Stockpile.

If investment minimums are too high, consider using a service like Stockpile, an online brokerage that lets people invest any dollar amount starting at $1. The site lets investors purchase fractional shares of brand-name stocks like Amazon.com (ticker: AMZN) or Facebook (FB). “If you get a $150 tax refund and Amazon is trading at $1,500 per share, you can purchase a tenth of a share,” says Stockpile co-founder and chief executive officer Avi Lele. You can also access domestic, international and sector indexes through exchange-traded funds. “A tax refund is the perfect way to kick-start an investment plan to build wealth for your future,” Lele says.


Adjust your tax withholding for next year.

While it may feel good to receive a check from the IRS, having too much withheld from your paycheck isn’t the best investing strategy. You’re technically “giving the government an interest-free loan” by letting them hold onto your money all year, Guerrini says. If you held onto that money, it could be earning interest for you instead. It may be better to owe money come tax season, he says. Just be careful that you set enough cash aside to pay the taxman next April.

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