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Here's How to 3X Your Retirement Savings

By Chuck Saletta – Sep 11, 2021 at 10:30AM

Key Points

  • Why not put the money you're overpaying to Uncle Sam throughout the year to work for you instead?
  • A 401(k) with an employer match can magnify the impact of your retirement plan contributions.
  • If you can increase your retirement savings with little impact to your day-to-day financial situation, why wouldn't you?

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Why not make your money work harder for you?

You might already be making a habit of using your annual tax refund to boost your retirement savings. After all, in most cases, it represents money you already earned but didn't need to spend throughout the year to cover your costs of living. As such, socking it away can be a fairly pain-free way to add to the amount of money that's working for your future.

What you might not realize, though, is that in many cases, it's possible to get three times the value of that money saved for your future with no additional sacrifice. It takes a little bit of extra effort, but if you can make your annual contributions worth thousands of dollars more, isn't it worth it?

Here's how to triple your retirement savings contributions by using your tax refund well.

Young woman holding lots of cash and winking.

Image source: Getty Images

Just how much opportunity is there?

According to the most recently published numbers from the IRS, the average taxpayer's refund in 2021 clocked in at around $2,775. Triple that, and it means an extra $8,325 in your retirement account. The median family income clocks in at just below $80,000, so that would represent a better than 10% retirement savings rate. That is a phenomenal foundation for a comfortable future, especially when you realize that you might be able to make it work without impacting your existing budget.

To make this kind of savings a reality, you'll need a handful of things:

  • Earned income from a job
  • The opportunity to adjust your tax withholding at work
  • A 401(k) with a match
  • The ability to contribute to an IRA
  • The aforementioned tax refund

The step-by-step approach

The first step is to contribute your tax refund to an IRA. As of 2021, contribution limits are generally $6,000 per year for people under 50 or $7,000 per year for those 50 and over. If your tax refund is near that $2,775 average, it would fit easily under that ceiling. Note that if you have the opportunity to get the money inside a Roth IRA -- either directly or via a backdoor Roth IRA contribution, it can be that much more powerful for you over time.

Next, boost your contributions to your Traditional 401(k) by the amount of your refund, adjusted for your marginal income tax rate. Say you're comfortably within the 22% federal and a 3% state tax bracket. You could increase your annual Traditional 401(k) contribution by around $3,700 (which is $2,775/(1-0.25)) to make use of your entire refund amount. That move would reduce your take-home pay by around $2,775 per year.

Next, you should adjust your tax withholding downward to aim for a breakeven result the next time you file your taxes. This step is an important part of making the whole thing essentially neutral in terms of affecting your ability to spend money throughout the year.

Don't worry if you can't get your withholding perfect, so that you neither owe anything to the IRS nor are owed anything by it. Legally, you're only required to prepay enough to be within a safe harbor before you have to true up the rest when you file your return. As long as you've prepaid at least 90% of what you owe or to within $1,000, you can make good on the rest by the April filing deadline with no additional interest or penalties.

Finally, let your employer's 401(k) match get you the rest of the way there. Matches differ from company to company, but a typical match is 50% of your contribution amount, up to some percentage of your salary. If all $3,700 of your increased contribution is eligible for a 50% match, that adds up to another $1,850 in your account.

It all adds up to 3X for your retirement

If you add up all the parts, you get:

  • $2,775 in your IRA
  • $3,700 from your contributions to your 401(k)
  • $1,850 from your boss' match to your 401(k)

That totals to $8,325 -- or exactly triple the original $2,775 refund amount. That's not a bad way to make some substantial progress toward your retirement savings goal. When you add in the fact that you got the original amount from a tax refund -- and not money you counted on from your paychecks -- it just feels that much more remarkable.

What are you waiting for?

There are few opportunities in life to give yourself such a big boost toward your long-term financial goals. There are even fewer that let you make that progress with almost no impact to your daily cash flow.

So make it a reality now. Once you get closer to retirement and see the impact this change has made on the size of your nest egg, you'll be glad you did.

Chuck Saletta has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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