Retire on Your Income Tax Returns by Taking These Steps

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For many households, getting tax refunds is the norm. Over-withholding, tax credits — refundable and nonrefundable — and deductions can all reduce a household’s tax burden. In some cases, the excess amount is sent to the IRS intentionally, as it allows households to receive what feels like a windfall every year. In others, it is incidental, as that wasn’t the household’s intention.

Regardless of the reasoning for the overpayment, the IRS issued more than 96 million tax refunds for the 2021 tax year. The total value of the refunds was over $292 billion, with the average refund coming in at $3,039.

In many ways, a refund can be an opportunity, particularly if you’re a bit behind on your retirement planning. If you want to fund your retirement using the refunds you receive after filing your taxes, here are some ways to make it happen.

1. Max Your Retirement Account

If you want to set your tax refunds aside for retirement, your first step can be to take the money and work to maximize your retirement savings. Since you can’t usually make lump sum deposits to a 401(k) through an employer, you may want to set up an IRA.

Whether you should aim for a traditional or Roth IRA mainly depends on a few factors, including when it’s better to capture the tax advantages. If you’re in a higher tax bracket now than you expect to be in retirement, a traditional IRA may make more sense. If your taxable income is lower than you believe it’ll be in retirement, then a Roth may be the way to go.

2. Open a Brokerage Account

There are annual limits to how much you can set aside in retirement accounts. In 2022, the IRA contribution limit is $6,000, plus an extra $1,000 if you’re age 50 or older. For 401(k)s, the limit is $20,500 for elective contributions, plus another $6,500 if you’re age 50 or older.

If you’re fully funding a retirement account but still want to use tax refunds to secure your financial future, opening a brokerage account could be a wise decision. You can get similar investments – including individual stocks, ETFs and other classic options – to what you find through 401(k)s and IRAs but that aren’t subject to the same limits.

While brokerage accounts aren’t tax-advantaged, they can potentially help your money grow. Plus, you don’t have to wait until you’re 59 ½ to tap into the account, making this a solid choice if you potentially want to use investments to retire early.

Before you go in this direction, come up with an investment strategy. Diversification should be part of the plan, as well as risk management in general. If you don’t have time to research options on your own, consider working with a financial advisor. That gives you access to an investment expert so you can choose options that align with your needs and preferences.

3. Consider Investing in Crypto

For those who are comfortable with volatility, using your tax refund to purchase some cryptocurrency could be an option. It’s a pathway toward diversification, though it carries far more risk than traditional investing.

Cryptocurrencies aren’t typically backed by an underlying asset. As a result, their values are primarily based on public perception and investor sentiment. That can lead to substantial swings in prices, at times in incredibly short time periods.

Whether crypto is or isn’t viable as a global currency isn’t fully clear. Plus, new regulations that alter the landscape could be on the horizon. Still, it may be an option worth considering for those looking for non-traditional ways to potentially secure their financial future — just remember to be careful, and keep your personal risk tolerance in mind.

4. Boost Your HSA Savings

If you’re eligible for a health savings account (HSA), sending your tax refund to that account could benefit you in retirement. The balance of an HSA can roll over from year to year. The money you contribute is also tax-deductible, and there are tax-free withdrawals if you use the money for qualified medical expenses.

Unlike some alternatives, an HSA can also follow you if you change jobs. You aren’t required to take distributions at any particular age either, allowing you to effectively hold the money as long as you want.

By boosting your HSA, you’re making health-related costs easier to shoulder moving forward. Since healthcare spending usually increases as a person ages, this can be a solid option for securing your financial future. 

Should You Intentionally Set Up a Tax Refund?

Most people view a tax refund as a positive. However, it isn’t necessarily the best way to secure your financial future.

While a tax refund can feel like a windfall, the IRS isn’t typically giving you extra money. Barring money relating to refundable tax credits, a refund mainly involves getting your own money back. It’s cash you’ve already given to the IRS; they’re simply returning the difference between what you owed in taxes and the amount you sent over during the year.

Since many households are essentially getting their own money handed back to them, the excess cash is like an interest-free loan made to the federal government. That cash simply builds up; it doesn’t grow as it would if you put it into an interest-bearing or other form of account that can lead to earnings.

Instead of allowing the federal government to hold your money interest-free, it’s better to adjust your withholdings. By lowering your withholdings, you end up with a slightly larger paycheck. Then, you can take the extra and put it in a high-yield savings, retirement or other kind of investment account. That way, that money has a chance to grow while you create a small nest egg, giving you a bit more than you’d have otherwise.