Should you save or spend your tax refund?

Should you save or spend your tax refund?

Time to read: 2 min

Tax season is upon us, and if there’s one upside to all that paperwork, it’s the prospect of receiving a tax refund.

According to the IRS, the average tax refund in 2018 was $2,899.1 Many consumers view this “extra” money as a kind of windfall, or unexpected gift. However, a tax refund is called that for a reason; after all, it represents money that was overpaid to the government. In reality, it’s simply a return of the interest-free loan you effectively granted the government the previous year.

Still, a large number of taxpayers prefer receiving an annual tax refund to reducing their paycheck withholdings. Some people put that money toward something fun, like a new car, a vacation or a shopping spree. Others use it to pay off loans or contribute to a major savings goal, like a new home. I have another suggestion: Use that refund to fund a 529 plan. 

Start saving for the future with a 529 plan

With the cost of higher education continuing to rise, starting early and saving often can be the difference-maker in determining how much of your children’s college tuition is funded. So, where can savers start?

The first step is to open a 529 plan. These tax-advantaged savings accounts help families save for future education costs.

Whether you’re saving for primary school or college, I believe 529 plans offer four key advantages over generic savings accounts:

  • Tax-advantaged earnings and distributions. Contributions to a 529 plan grow tax-deferred, and withdrawals are tax-free so long as they’re used for qualified educational expenses (i.e., government-approved costs like tuition, room and board, and textbooks).2
  • Fewer restrictions. Unlike many savings plans, 529 plans have no time or age restrictions. Savers can contribute at any point in the beneficiary’s life, whether they’re an infant or a grandparent. Furthermore, where some plans (like Coverdell Education Savings Accounts) base contributions on income, 529 plans have no income limits. There’s no maximum income to contribute, and no minimum contribution to get started.
  • Greater flexibility. Many families wonder what will happen to their funds if their child receives a scholarship or defers college enrollment; they don’t want to see their hard-earned savings go to waste if their child’s plans change. Some savings plans (such as UGMA/UTMA Custodial Accounts) don’t allow for beneficiary changes, so those funds must be used for the designated recipient. But 529 plan beneficiaries can be changed at any time to another member of the beneficiary’s family, from a sibling or cousin to the account owner themselves.
  • Control for the account owner. I’ve watched three kids graduate from college, so I understand that no parent is comfortable handing their child a lump sum of money and crossing their fingers it’s spent wisely! 529 plan account owners maintain complete control at every step of the savings process, from choosing the investment portfolios, designating (or redesignating) the beneficiary, and ultimately, distributing the funds. And again, since those funds can only be applied toward qualified educational expenses, they can only be used for their intended purpose — no dorm-wide pizza parties or shopping sprees.

So, if you’re on the receiving end of a tax refund this tax season, my recommendation is clear: Consider opening or adding to a 529 plan. It’s a smart solution for funding your child’s future — and that’s one investment that never goes out of season!

Learn more about the differences between college savings plans, then read more about retirement and education strategies from Tom Rowley.

1 Source: Bankrate, “This was the average tax return last year,” Michelle Black, Feb. 21, 2019

2 Earnings on non-qualified withdrawals may be subject to federal income tax and a 10% federal penalty tax, as well as state and local income taxes. Tax and other benefits are contingent on meeting other requirements and certain withdrawals are subject to federal, state, and local taxes. 

Important information 

Blog header image: ImagePixel/Shutterstock 

Thomas Rowley
Director, Retirement and Education Strategies

Thomas Rowley is director of retirement and education strategies and one of Invesco’s most frequently requested speakers. He provides analysis of the evolving retirement landscape and develops actionable strategies to help investors and financial advisors maximize their retirement-planning opportunities. Mr. Rowley regularly shares his insights online at invesco.com/us in addition to his speaking engagements.

Mr. Rowley’s insights reflect more than 20 years of experience in the investment industry. He translates his comprehensive knowledge of retirement planning into lively, clear explanations of the complexities of legislative, investing, tax and social issues.

Mr. Rowley shares his analyses of retirement-related issues through regular personal appearances, continuing education webinars and Web-based commentaries.

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