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Turn Taxes Into Retirement

According to most studies, including this one conducted by Allstate (NYSE: ALL  ) , the biggest reason Americans don't save for retirement is a lack of "disposable" income. After paying the bills, who has money left over for so-called elective contributions to a retirement account?

In fact, you might have some extra money right now that's being held by someone else: Uncle Sam. Like most Americans, you probably have too much money withheld from your paycheck. And we're not talking chump change. According to the Internal Revenue Service, the average tax refund so far this year is $2,423.

While it's nice to get that check in the mail, you don't have to wait until you file your taxes and receive your refund to increase your new worth. You can adjust your withholding now and begin taking home more pay within weeks.

But if you're behind in your retirement savings, please don't spend that extra cash. Instead, sign up for your company retirement plan or open an Individual Retirement Arrangement (IRA). If a 40-year-old contributed that $2,423 refund annually for 25 years to an IRA and earned an average 8% a year, he or she'd add more than $200,000 to the nest egg. But act now -- you have until April 17, 2006, to make a 2005 contribution to your IRA.

A sizeable tax refund isn't the only reason to adjust your tax withholding. Others include a major life change (marriage, divorce, birth of a child), a change in income (a big raise or move to part-time), new deductions (a mortgage), and taking advantage of higher contribution limits to most retirement accounts in 2006 (which may reduce your taxable income).

How do you calculate your new withholding? Use the IRS' online withholding calculator. You'll need a recent pay stub and your most recent tax return to complete the rigmarole. Once you've calculated your proper withholding, submit a new W-4 with your employer. Then immediately sign up for, or increase your contributions to, your retirement plan at work. However, if your contributions aren't matched by your employer, you might be better off in an IRA. To learn more, visit our IRA Center.

Robert Brokamp is the editor oftheMotley Fool Rule Your Retirementnewsletter service. He received a huge tax refund on account of being able to claim the adoption tax credit in 2005. He still lost money on the deal, but his daughter is one of the best investments his family has ever made.


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