Expecting a refund on your taxes this year? Here's how to maximize that value of your IRS check. February 17, 2003: 3:00 PM EST
By Sarah Max, CNN/Money Staff Writer
New York (CNN/Money) -
Tax season isn't all bad news. The Internal Revenue Service estimates nearly 100 million filers will receive a refund this year.
For most Americans, this is no small chunk of change. In fact, the average refund mailed out last year was $1,999. (Click here to estimate your refund.)
Sure, you could probably think of a hundred different places to spend this windfall. But before you blow it, consider five ways to turn your refund into a financial gift that will keep on giving.
Pay off high-interest debt
The average household carries a whopping $8,500 in credit card and department store revolving debt, according to Chris Viale, general manager of Cambridge Credit Counseling Corp.
Even if your balance is well below this average, you're wise to put your refund toward any high-interest debt you have first.
Consider that if you carry $5,000 in credit card debt, pay 18 percent in interest and only make the minimum payment (which would be $100 for most issuers), by the time you pay off this debt – almost 33 years later – you will have paid more than $2 in interest for every $1 you charged.
"It's virtually impossible to get that type of return investing," said Viale.
(To see how much money you're wasting on high-interest debt, check out CNN/Money's Debt Planner.)
Start saving for Harvard
College isn't getting any cheaper. The average cost of tuition and fees rose 9.6 percent at four-year public schools and 5.8 percent at private schools this academic year, according to the College Board.
State-run 529 college savings plans are among the most effective ways to sock money away for college. This is because earnings and dividends in your 529 portfolio are not taxed on an annual basis, and withdrawals for qualified expenses are exempt from federal income tax. If you put just $500 of your refund into a plan with an average annual return of 8 percent, in 18 years your contribution with quadruple to $1,999.
Compound Interest Calculator
TAX REFUND SAVINGS CALCULATOR
Prepaid tuition plans, another form of 529s, are also a great way to save. Such plans are offered in 20 states and allow participants to buy education contracts or units at today's prices to be used for tuition in the future, with any appreciation in value exempt from federal taxes. Although the plans were designed to prepay tuition at states' own public schools, most plans now allow you to transfer the value of your tuition to private schools and out-of-state public schools.
Nearly every state has either a savings or prepaid plan, and many have both. (Check out Savingforcollege.com for details on every state's plan.) And in about half of all states, including Michigan, New York and Oregon, these plans get tax-friendly treatment on the state level as well.
Contribute to an IRA
If you don't have college education to worry about, consider putting the money toward your golden years. In 2003 you and your spouse may each be eligible to contribute as much as $3,000 ($3,500 if you're over age 50) to an individual retirement account (IRA) or a Roth IRA. (For details on contribution limits click here.)
You can realize immediate tax savings by opting for a traditional IRA, in which case contributions are not taxed at the federal or state level. You will, however, be subject to income tax when you withdrawal money from the fund down the road.
If you think you'll be in a higher tax bracket by the time you retire, opt for a Roth IRA. You won't be able to deduct contributions from your income now, but when it comes time to withdrawal that money for retirement you won't owe any income tax on the earnings, provided the Roth has been open for five years. (First-time homebuyers can also qualify for tax-free withdrawals, though there are certain restrictions.)
Sink it into your house
By updating that old bathroom, replacing your shag carpeting or even just planting a few trees in your yard you'll not only make living in your house more pleasant, you may boost your home's resale value as well.
According to a survey of real estate agents by HomeGain, there are 10 kinds of home improvements that increase the value of your property by far more than the actual cost to do them. For example, they estimate that painting your interior walls will cost anywhere from $1,453 to $1,588, but this investment will add $2,342 to $2,600 to your resale value.
(For a quick look at how much home improvement projects are likely to return on the resale market, click here.)
You don't have any high-interest debt, you've already contributed to an IRA and 529 plans, and your house is spiffy as it is. Now, before you treat yourself, consider giving at least a portion of your tax return to one of your favorite charity organizations.
In doing so, you'll not only do some good, you'll get a little back next year in the form of – you guessed it – another deduction.
For example, if your taxable income is $50,000, and you donate $1,000 of your tax refund to a qualified tax-exempt organization, your gift will translate to another $270 in tax savings next year.
To qualify you do need to itemize deductions, rather than take a standard deduction. But because the limits on charitable donations are high, the only thing you really need to worry about is making sure your favorite cause is a qualified tax-exempt organization, keeping track of all your donations and getting a receipt for gifts of $250 or more.
After all, as you may have figured out when doing this year's return, it's often the little things that add up to a nice fat refund check.