The April 15 tax-filing deadline has already come and gone, so at this point, hopefully, you have sent in your 2023 return and are awaiting your refund. As of April 5, the average tax refund issued by the IRS this filing season was $3,011.
That number could change in the coming weeks as the IRS continues to process returns. But all told, if you're due a refund, it might be a substantial one.
Now, let's get one thing quickly out of the way. A tax refund is not a gift from the IRS. Rather, it's money you should have collected in your wages all along but didn't.
And because of this, it's really important to try to put your refund to good use. So if you've been struggling to fund your 401(k) or IRA this year, then a retirement plan could be the perfect place for your newfound money.
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The upside of using your tax refund for retirement savings
These days, many consumers continue to struggle with persistent inflation. Living costs were up 3.5% annually in March, as per that month's Consumer Price Index. And a lot of people are barely managing to cover their basic bills, leaving them with little to no money for retirement savings.
That's why allocating your tax refund to your 401(k) or IRA could be such an effective move. Not only might contributing to one of these accounts help lower your 2024 tax burden (assuming you fund a traditional retirement savings plan, as opposed to a Roth account), but the sooner you put money into a retirement plan, the sooner you can benefit from compounding returns in that account.
Over the past 50 years, the stock market's average annual return has been about 10%. That accounts for strong years and weak years.
So let's say you're getting a $3,000 tax refund this year and you put it into a retirement account rather than spend it. If you sit back and do nothing for the next 30 years, that $3,000 might be worth a little more than $52,000, assuming that your portfolio also delivers an average annual 10% return. And even if you're hardly a stock-picking wizard, if you load up on S&P 500 index funds in your portfolio, there's a good chance you'll be looking at a return in that vicinity.
A great thing to do for your future
To be clear, if you're sorely lacking in near-term emergency savings or can't afford to feed your family or purchase necessary medication without spending some of your tax refund, then by all means use that money to address your near-term needs first. You shouldn't skimp on essentials now when you might still have many years to come up with a plan to boost your retirement savings.
But if you're managing to get by despite persistent inflation, and you're OK on emergency savings, then it definitely pays to invest your tax refund in a retirement plan and see where that takes you. This holds true no matter how much money the IRS is sending you this April.
