Investing Your Tax Refund? Here's How Much Wealthier It Could Make You

Getting money back from the IRS during tax season is by no means a given. But it may interest you to know that this year, as of March 3, the IRS had issued more than 36 million refunds. And the average refund amount was $3,182. 

Now, since there's more time to go in the tax season, that average refund can certainly change. But it's clear that among those who have received a refund so far, the average amount has been pretty substantial.

If you're in line for a tax refund this year, you may be inclined to spend that money on something fun -- maybe a new phone and TV or a nice vacation. But here's why it really pays to consider putting your tax refund into an investment account instead.

You can potentially grow that money into a much larger sum

Any time you invest money, you take on the risk that you might lose some or all of it. But if you commit to investing over a lengthy period, that's less likely.

Case in point: Over the past 50 years, the stock market has averaged an annual 10% return. But there were plenty of periods during that half-century window when the market sustained prolonged losses. That 10% accounts for periods of growth and losses. 

Now, let's talk about your tax refund. Maybe you're getting a little more than $3,182. Or maybe you're getting less. But to illustrate the benefit of investing that money, let's assume that your refund check amounts to $3,182, and that you invest it in a stock portfolio that delivers an average annual 10% return over the next 40 years. If so, you're looking at turning that $3,182 into $144,000. That's a pretty sweet deal.

Consider investing in a retirement plan

Of course, there's one hiccup you might encounter when you invest your money and enjoy a nice gain -- having to pay taxes on that gain. But if you invest your tax refund in a retirement plan like an IRA or 401(k), you can soften or even eliminate that tax hit.

With a traditional IRA or 401(k), your investment gains are tax-deferred. The IRS doesn't collect taxes from you year after year as your portfolio gains value. Rather, you're taxed at the time you take withdrawals, which is generally during retirement.

With a Roth IRA or 401(k), though, your investment gains are tax-free. So in the above example, if you were to put that $3,182 into a Roth IRA and grow it into $144,000, you'd enjoy about $141,000 in gains without having to pay the IRS a dime. 

It can be super tempting to spend your tax refund on something enjoyable that will improve your life in the near term. But investing your refund could truly improve your financial situation in the long term. So consider not only investing that money, but choosing a tax-advantaged account to minimize your capital gains tax impact.