Tax refund documents and cash on a table

April 13, 2018

6 Smart Ways to Use Your Tax Refund

Many taxpayers will be receiving a potentially large tax refund after over-withholding their 2018 taxes. While it's never a good idea to make an interest-free loan to the government, it is sometimes hard to avoid overpaying.

How to Get the Most Out of Your Tax Refund

If you find yourself with a sudden infusion of cash from your return, these are a few financially responsible ways to put that money to use.

Make a Charitable Donation

Using your refund to make a contribution to a cause is not only a simple way to give back, but doing so will also generate tax deductions that can help reduce your 2019 tax burden, said Paul DeLauro, City National Bank's manager of wealth planning. When making a tax-deductible donation, make sure it goes to a nonprofit entity that is approved by the IRS.

Invest Your Return

While many people are tempted to use their refunds on a splurge purchase, such as a luxury vacation or vehicle, don't forget about your longer-term goals.

"Allocate a portion of the refund to your overall investment portfolio," advised DeLauro.

Contribute to an IRA Account

Do you have any IRA accounts? If not, you may have a Roth IRA funding opportunity. The following concept works best if you have no money in IRA balances, so it's important to work closely on this with your financial planner and tax advisor.

IRAs and Roth IRAs permit contributions of up to $5,500 per year (with a $1,000 additional “catch-up" contribution if you are over 50). IRAs may be funded with pre-tax or after-tax contributions. Roth IRAs are only funded with after-tax contributions. Once you reach certain modified adjusted gross income thresholds, only after-tax contributions are permitted for IRAs and you are not permitted to contribute directly to a Roth IRA.

Ideally, you would want to contribute a portion of your refund to a Roth IRA. However, if you are unable to do so because your income is too high, you could fully fund your IRA with after-tax contributions and then convert those contributions to a Roth IRA. Over a 20-year period, you could fund more than $100,000 in a Roth IRA via this conversion technique, all with after-tax dollars growing and being distributed tax-free. You can fund your 2018 IRA or Roth IRA until April 15, 2019; if your refund is in excess of $5,500 (or $6,500 for those over 50) you could also contribute to your 2019 IRA.

Add to a College Fund

If you have children or grandchildren, some of your refund could be used to fund college education plans known as 529 plans. Those allow you to gift up to $14,000 per child (or $28,000 per child for married couples) per year. There are two types of 529 plans: a college savings plan and a pre-paid tuition plan.

Neither plan is tax-deductible. However, you will not have to pay tax on the income your investment earns annually. As long as you use the funds to pay for qualified higher education expenses — books, tuition, room and board — you will never pay income tax when you put the money to use.

Put Towards Your Irrevocable Life Insurance Trust

If you have an estate plan in place that includes an Irrevocable Life Insurance Trust (ILIT) — a life insurance policy used strategically to help pay for estate taxes and protect wealth — consider earmarking your refund for your annual premium gifting. This is also a good time to review whether the policy is performing as promised, whether the trustee is performing his or her duties according to the law, and whether you still need the policy.

Pay Down Debt

If you have debt — high-interest credit card debt, mortgages on your primary or secondary home, or home equity lines of credit — consider using some or all of the refund towards paying off that debt, DeLauro advised.

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This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.

City National, as a matter of policy, does not give tax, accounting, regulatory or legal advice. Rules in the areas of law, tax, and accounting are subject to change and open to varying interpretations. You should consult with your other advisors on the tax, accounting and legal implications of actions you may take based on any strategies presented, taking into account your own particular circumstances.

It is not to be construed as an offer, or solicitation of an offer, to buy or sell any financial instrument. It should not be relied upon as specific investment advice directed to the reader's specific investment objectives. Any financial instrument discussed in this article may not be suitable for the reader. Each reader must make his or her own investment decision, using an independent advisor if prudent, based on his or her own investment objective and financial situation. Prices and availability of financial instruments are subject to change without notice. Financial instruments denominated in a foreign currency are subject to exchange rate risk in addition to the risk of the investment. City National (and its clients or associated persons) may, at times, engage in transactions in a manner inconsistent with this article and, with respect to particular securities and financial instruments discussed, may buy from or sell to clients or others on a principal basis. Past performance is not necessarily an indication of future results.

*Securities offered through City National Securities, Inc. (member FINRA/SIPC) and a wholly owned subsidiary of City National. Deposits maintained with City National are not SIPC insuredAn investor should consider the investment objectives, risks, charges, and expenses associated with municipal fund securities before investing. More information about municipal fund securities is available in the issuer's official statement.

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