Four Ways to Double the Power of Your Tax Refund

The IRS expects that more than 70 percent of taxpayers will receive a refund in 2017. What you do with a tax refund is up to you, but here are some ideas that may make your refund twice as valuable.

Double your savings

Perhaps you’d like to use your tax refund to start an education fund for your children or grandchildren, contribute to a retirement savings account for yourself, or save for a rainy day. A financial concept known as the Rule of 72 can give you a rough estimate of how long it might take to double what you initially save. Simply divide 72 by the annual rate you hope that your money will earn. For example, if you invest your tax refund and it earns a 6% average annual rate of return, your investment might double in approximately 12 years (72 divided by 6 equals 12).

This hypothetical example of mathematical compounding is used for illustrative purposes only and does not represent the performance of any specific investment. Fees, expenses, and taxes are not considered and would reduce the performance shown if they were included.

Split your refund in two

If stashing your refund away in a savings account or using it to pay bills sounds unappealing, go ahead and splurge on something for yourself. But remember, you don’t necessarily have to spend it all. Instead, you could put half of it toward something practical and spend the other half on something fun.

The IRS makes splitting your refund easy. When you file your income taxes and choose direct deposit for your refund, you can decide to have it deposited among two or even three accounts, in any proportion you want. Qualified accounts include savings and checking accounts, as well as IRAs (except SIMPLE IRAs), Coverdell Education Savings Accounts, health savings accounts, Archer MSAs, and TreasuryDirect® online accounts. To split your refund, you’ll need to fill out IRS Form 8888 when you file your federal return.

Double down on your debt

Using your refund to pay down credit card debt or a loan with a high interest rate could enable you to pay it off early and save on interest charges. The time and money you’ll save depend on your balance, the interest rate, and other factors such as your monthly payment. Here’s a hypothetical example. Let’s say you have a personal loan with an $8,000 balance, a 12% fixed interest rate, and a 24-month repayment term. Your fixed monthly payment is $380. If you were to put a $4,000 refund toward paying down your principal balance, you would be able to pay off your loan in 12 months and save $780 in interest charges over the remaining loan term. Check the terms of any loan you want to prepay, though, to make sure that no prepayment penalty applies.

Be twice as nice to others

Giving to charity has its own rewards, but Uncle Sam may also reward you for gifts you make now when you file your taxes next year. If you itemize, you may be able to deduct contributions made to a qualified charity. You can also help your favorite charity or nonprofit reap double rewards by finding out whether your gift qualifies for a match. With a matching gift program, individuals, corporations, foundations, and employers offer to match gifts the charitable organization receives, usually on a dollar-for-dollar basis. Terms and conditions apply, so contact the charitable organization or your employer’s human resources department to find out more about available matching gift programs.

Converting Retirement Savings to Retirement Income

You’ve been saving diligently for years, and now it’s time to think about how to convert the money in your traditional 401 (k)s (or similar workplace savings plans) into retirement income. But hold on, not so fast. You may need to take a few steps first.

Evaluate your needs

If you haven’t done so, estimate how much income you’ll need to meet your desired lifestyle in retirement. Conventional wisdom says to plan on needing 70 to 100 percent of your annual pre-retirement income to meet your needs in retirement; however, your specific amount will depend on your unique circumstances. First identify your non-negotiable fixed needs– such as housing, food, and medical care–to get clarity on how much it will cost to make basic ends meet.

Then identify your variable wants –including travel, leisure, and entertainment. Segregating your expenses into needs and wants will help you develop an income strategy to fund both.

Assess all sources of predictable income

Next, determine how much you might expect from sources of predictable income, such as Social Security and traditional pension plans.

Social Security: At your full retirement age (which varies from 66 to 67, depending on your year of birth), you’ll be entitled to receive your full benefit. Although you can begin receiving reduced benefits as early as age 62, the longer you wait to begin (up to age 70), the more you’ll receive each month. You can estimate your retirement benefit by using the calculators on the SSA website, ssa.qov. You can also sign up for a My Social Security account to view your Social Security Statement online.

Traditional pensions:

If you stand to receive a traditional pension from your current or a previous employer, be sure to familiarize yourself with its features. For example, will your benefit remain steady throughout retirement or increase with inflation? Your pension will most likely be offered as either a single life or joint-and-survivor annuity. A single-life annuity provides benefits until the worker’s death, while a joint-and-survivor annuity generally provides reduced benefits until the survivor’s death1.

If it looks as though your Social Security and pension income will be enough to cover your fixed needs, you may be well positioned to use your other assets to fund those extra wants. On the other hand, if your predictable sources are not sufficient to cover your fixed needs, you’ll need to think carefully about how to tap your retirement savings plan assets, as they will be a necessary component of your income.

Understand your savings plan options

A key in determining how to tap your retirement plan assets is to understand the options available to you. According to the Government Accountability Office (GAO), only about one-third of 401 (k) plans offer withdrawal options, such as installment payments, systematic withdrawals, and managed payout funds2. And only about a quarter offer annuities, which are insurance contracts that provide guaranteed income for a stated amount of time (typically over a set number of years or for the life expectancy of the participant or the participant and spouse3).

Plans may allow you to leave the money alone or require you to take a lump-sum distribution. You may also choose to roll over the assets to an IRA, which might offer a variety of income and investment opportunities, including the purchase of annuity contracts. If you choose to work part-time in retirement, you may be allowed to roll your assets into the new employer’s plan.

Determining the right way to tap your assets can be challenging and should take into account a number of factors. These include your tax situation, whether you have other assets you’ll use for income, and your desire to leave assets to heirs. A financial professional can help you understand your options.

For more information, contact Darryl S. Lewis of Waddell & Reed 708-229-1500, x122 or email dslewis25915@wradvisors.com.


1 Current law requires married couples to choose a joint-and-survivor annuity unless the spouse waives those rights.

2 401{k) Plans: DOL Could Take Steps to Improve Retirement Income Options for Plan Participants,” GAO Report to Congressional Requesters, August 2016.

3 Generally, annuity contracts have fees and expenses, limitations, exclusions, holding periods, termination provisions, and terms for keeping the annuity in force. Most annuities have surrender charges that are assessed if the contract owner surrenders the annuity. Qualified annuities are typically purchased with pre-tax money, so withdrawals are fully taxable as ordinary income, and withdrawals prior to age 59½ may be subject to a 10% penalty tax. Any guarantees are contingent on the claims-paying ability and financial strength of the issuing insurance company. It is important to understand that purchasing an annuity in an IRA or an employer-sponsored retirement plan provides no additional tax benefits other than those available through the tax-deferred retirement plan.

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