If you’re one of the millions of Americans receiving a tax refund this year (about 76% of taxpayers received one in 2020 according to LendingTree) and are wondering “What to do with my refund?” Here's a suggestion: consider investing your tax refund for the future.
To invest tax refund money rather than spending it on immediate gratification is a good way to prepare for the future. Some of the reasons you might want to invest tax money rather than using it to buy luxuries or go on a date night (though that can be a good and thoughtful way to show appreciation to your significant other) include:
It’s very easy to underestimate just how much money you’ll need to live the lifestyle you want in retirement. Setting up additional revenue streams by making smart investments now can help you secure the funds you need to live a free and independent life after work.
For example, you could make an additional contribution to one of your annuities to help increase the payout you’ll see from it in the future. This can help you meet your retirement goals and live the lifestyle you want.
According to debt.org, “American household debt hit a record $16.9 trillion at the end of 2022.” The majority of American citizens carry some form of debt—and that debt can have a severe impact on their lifestyle in retirement.
For many, their retirement income will be a fraction of the income they earned while working. So, it isn’t uncommon for Americans to keep working even after reaching retirement age simply to cover the cost of their debt.
Using tax refund money to pay down debt can be one highly effective “investment” in your future. Although a single refund check won’t typically be enough to wipe out major debts, the money you save on interest for credit card debt and other forms of debt can help you in the long run.
Life can be unpredictable… and expensive. Unexpected events can put an enormous dent in your finances. For example, a surprise injury or illness can be incredibly costly even with insurance. According to debt.org, the “average per-day hospital cost in the U.S. is $2,883” and the “average hospital stay is 4.6 days.”
This would mean that, on average, a trip to the hospital would require $13,262 of savings to pay for immediately—not counting any surgery costs, which can easily cost six figures per operation depending on the need for things like anesthesia, special surgical equipment, or specialists.
While health insurance helps cover many of these expenses, patients are still expected to handle their deductibles and copays for hospital visits, medication, and certain other expenses not covered by their insurance plan. Also, not every hospital will be “in network” for every insurance plan.
Having money set aside for paying these bills can be crucial for avoiding excessive debt following a major injury or illness.
A higher education is often touted as the gateway to better career opportunities and income later in life. The Federal Reserve Bank of New York’s Liberty Street Economics publication noted that “the average college graduate with just a bachelor’s degree earned about $78,000, compared to $45,000 for the average worker with only a high school diploma.” That’s an additional $33,000 per year in earnings, or 73.3% more income for the bachelor’s degree holder.
So, sending your kids to college makes a lot of sense as a way to help them achieve success later in life.
However, while college has proven to help Americans earn more money, it has also become increasingly more expensive. While the cost of college can vary depending on the choice of school, whether your child is an “in-state” or “out-of-state” student, and what scholarships and other forms of financial aid they qualify for, it’s still expensive.
For example, data cited by U.S. News states that, for the 2022-2023 school year, the cost of college for a year in a private school is about $39,723 while a public, in-state college education would be about $10,423 for that same time period.
In the 2012-2013 school year, a public, in-state college would have averaged $8,655 and private institutions would have averaged $29,056 (Source: College Board). In other words, the average cost of college has increased by $1,768 per year for public in-state students and by $10,667 for private institution students.
This can be far too much to expect a young college-age student to cover on their own as they’re trying to focus on school work. By setting up some investments now and letting them passively grow, you can help put your kids through college by funding them so they don’t have to rely as heavily on student loans that leave them in debt after graduation.
So, you’ve set a goal you want to use your tax refund on in the future, whether it’s financing your retirement, putting the kids through college, or simply putting aside money for a rainy day. The next question is “what’s the best way to spend my tax refund if I invest it?” There are many kinds of investments that you can pick from to help you meet your future financial goals.
Here are five ways that you could choose to invest your tax refund to meet different goals.
Annuities are investments where you can pay some money to create a series of payments over time in the future. The initial investment period is called the accumulation phase while the period after it starts paying out is called the annuitization phase.
You can structure an annuity in many ways to meet different goals. For example, you can choose to set up an annuity that is immediate (meaning it starts paying as soon as it’s set up) or deferred (meaning it starts paying at some future date so the money has a chance to grow).
Your choice of annuity type will vary depending on your financial situation. If you want to give that tax money plenty of time to grow and use it for retirement, you may want to put it towards a deferred annuity. Meanwhile, if you have a really large tax refund and don’t want to spend it all at once (so you can handle some smaller bills or the like), you could put it into an immediate annuity that makes regular payments over the course of a year or two.
Playing the stock market is another popular choice for moderate-to-long-term investments that sounds like a great idea. However, earning money on stocks can be incredibly difficult—even for professionals who specialize in the task!
As noted by Bankrate, “stocks are volatile in the short-term, so only invest the money if you’re confident you won’t need it in the next five years or so.” Rather than investing in specific companies that might not last, many investors, both professionals and amateurs, invest in mutual funds to build a diverse portfolio of stocks that reduce risk.
Investing in the stock market, especially if you pick individual stocks that change significantly in value, can be a high-risk, high-reward proposition. Additionally, if you use a financial advisor or a “robo-advisor” to manage your stocks on your behalf, you may end up spending a significant amount of the money you could make through the market on fees and other hidden costs.
As such, stocks may be less reliable than other investment types. It may help to speak with a certified financial planner before investing any money in the stock market.
If you have any large debts with high interest amounts, one of the best investments to make may just be paying down that debt as soon as possible.
As noted by The Motley Fool, the “stock market has returned an average of 10% per year over the past 50 years.” However, actual returns can vary wildly from year-to-year. If you have any debt that accumulates interest at a rate of more than 10% per year (and especially if that interest compounds), paying that debt down may help you save more money in the long run than you might have earned in investments over the same time period.
For example, the average credit card interest rate as of April 17, 2023 was 24.20% (Source: Forbes). Let’s say you have a tax refund of $2,000. If you invested it into the stock market and made 10% interest compounded year-over-year, then after 10 years, you would have $5,187.48 if you made no additional contributions.
Meanwhile, if you had $2,000 of credit card debt at the average interest rate of 24.20%, after ten years, that debt would grow to $17,468.11 of debt if you made no payments on it. If a penny saved is a penny earned, paying down that debt would earn you $12,280.63 more than investing the money would.
Even if you paid $50/month on that debt, you would be making monthly payments for 91 months (or more than $4,500) before eliminating it completely—largely negating the benefit of investing the rest of the money.
Another way to invest your tax refund is to put it into a preneed insurance plan. This is a type of insurance policy that helps cover the cost of funerals and other end-of-life expenses so that they don’t eat into the estate that you leave behind for your inheritors.
While this can be a grim subject, using your tax return to acquire a preneed insurance plan can be a good way to fund the celebration of your life without placing a burden on your loved ones.
Want to maximize your estate for your loved ones? Consider using your tax refund to make a down payment or an additional contribution on a life insurance policy.
When choosing to invest in a life insurance policy, it’s important to consider what type of policy best fits your needs. For example, is a term life policy, which has a limited period of time it is valid for at a lower cost, better for your needs than a whole-life policy that will be good until the death of the policyholder?
Considerations like how much you have available to invest, your life expectancy, and your overall goals for the insurance policy will all be important for choosing the best policy to meet your needs.
ELCO Mutual offers a variety of annuity, preneed insurance, and life insurance products to fit your needs. Connect with an ELCO Mutual agent today to learn more!
If you have additional questions about investment options, it is highly recommended that you speak with your financial advisor to get real advice that takes into account your specific financial situation and goals. This blog is not intended to serve as financial advice—it is merely intended to educate you about some of your options and help you better understand them.