|
Spending your tax rebate
|
 |
June 7, 2001: 1:17 p.m. ET
Use your refund to pay off debt, create a savings cushion or fund an IRA
By Staff Writer Shelly K. Schwartz
|
NEW YORK (CNNfn) - The $1.35 trillion tax cut signed into law by President Bush Thursday is widely expected to jump-start the lagging economy as various relief initiatives are phased in over the next 10 years.
But it also will have a very real and immediate impact on millions of working Americans, in the form of tax rebates being mailed out beginning in mid-July.
To be sure, the rebate checks will be a financial windfall for no one. The maximum amount any taxpayer will receive is $600, enough for a mini-vacation or a new washer and dryer. But not enough to make a dent in your finances.
Or is it?
Kim Dignum, a certified financial planner with Dignum Financial Services in Fort Worth, Texas, said there's plenty taxpayers can do with their unexpected paycheck. And she notes it's a perfect way to start some good habits.
"This is found money so if you're not contributing to an IRA already, this is a good time to start," she said.
Who's getting what?
(Click here for more on what tax relief means to you.)
Under the new legislation, married couples will receive a tax rebate of up to $600, single taxpayers can expect to receive up to $300 and single parents will receive a maximum of $500 by Oct. 1.
"Most families can look forward to a $600 tax rebate before they have to pay the September back-to-school bills," President Bush said in signing the bill into law. "And in the years ahead, taxpayers can look forward to steadily declining income tax rates."
The law provides an across-the-board tax rate cut, dropping the lowest rate from 15 percent to 10 percent, and the highest rate from 39.6 percent to 35 percent over the next few years. Once all the provisions are phased in, the bill will double the child tax credit from $500 to $1,000, reduce the tax penalty on married couples and fully repeal the tax on estates.
All told, some 43 million married couples will see their taxes lowered by $1,730; 38 million families with children will receive an average tax cut of $1,463 to help pay for education, childcare, and other expenses; and 11 million single mothers with children will be able to keep, on average, $780 more of their income each year.
At the same time, 13 million seniors will enjoy a $924 reduction in their annual taxes and 3.9 million individuals and families will have their income tax liability completely eliminated by the Economic Growth And Tax Relief Reconciliation Act Of 2001, the first major tax cut in 20 years.
Putting your refund to work
By and large, most taxpayers who receive a refund check are expected to spend it on appliances, travel plans and consumer goods, providing just the sort of economic fuel the government seeks.
But job security is waning amid massive corporate layoffs and financial planners say they expect a least a few clients to take a more responsible approach.
If you're among them and you're looking for ways to put your refund check to work, experts say it's best to apply that money to your debt levels first. Interest rates on many credit cards can climb as high as 20 percent or more, costing you big bucks if you carry a balance. Don't forget, too, that the interest you pay is not tax-deductible.
"One of the problems people have is that it's fun to do the investing side of things, but they have to have their house in order before they can do that," said Dignum, the Fort Worth financial planner. "When you go through the checklist, the first thing you need to knock out is debt. The second thing you need to have is an emergency reserve. And the third is to invest."
Many planners suggest individuals maintain in a liquid account 3 months worth of living expenses to cover themselves in the event of an unexpected medical emergency, car troubles or job loss.
If you have no debt to speak of and you're comfortable with the size of your rainy day fund, you're ready to begin applying extra dollars towards long-term investments.
A good place to start: your retirement account, where even small contributions can amount to a big chunk of change over the years.
Building your nest egg
In a Roth IRA, for example, a $300 contribution would grow to $5,234.82 over 30 years and a $600 contribution would grow to $10,469.64 over that same time period, assuming a 10 percent rate of return.
"They are raising IRA limits (to $5,000 from $2,000 over the next few years) and people who are eligible should contribute," Dignum said.
She notes, too, that most taxpayers should opt for the Roth IRA rather than a traditional IRA. Contributions to Roths are made on an after-tax basis, but the earnings are withdrawn on a tax-free basis upon retirement. Traditional IRAs work just the opposite. Contributions to traditional IRAs are deductible against your income, but the earnings are taxed when they're withdrawn.
"I recommend Roths to most people because they are such a good deal," Dignum said. "Someone very young who contributes to a Roth enjoys tax-free accumulation for 30 to 40 years."
Saving for college
If you've got kids headed for college, experts say you may also want to drop that refund check into a 529 plan, or a state-sponsored tuition plan.
Such plans allow for after-tax contributions, which are invested in a pre-selected portfolio of equities and bonds.
Previously, earnings in 529 plans grew tax-deferred until withdrawn, at which time they were taxed at the student's rate of 15 percent. Under the new legislation, however, earnings in such funds can be withdrawn tax free if used to pay for qualified education expenses.
"Instead of being a tax-deferred savings vehicle, it's now a tax-free savings tool," said John Duncan, a certified financial planner with J. Duncan & Associates in Tacoma, Wash. "These are looking like a great option."
Duncan said, too, that the new tax relief legislation also allows for easier transfers.
Previously, if a grandparent set up a 529 plan for their son's child, and that child ultimately decided not to attend college, the money would have to be transferred to another child in that same family. Now, those rules have been relaxed, allowing the grandparent to transfer the balance to another grandchild from, say, their daughter's family.
And how much could that tax rebate check grow to in a state-sponsored tuition plan?
If you had dropped $600 into a 529 plan 18 years ago when your child was an infant, your child today would have $6,240 in tax-free funds sitting in the bank to use toward tuition. That calculation uses the 13.9 percent compounded rate of return over the last 18 years for investment funds typical of 529 plans, which often invest 60 percent in equities and 40 percent in fixed-income securities like bonds.
"This is a remarkable development for families with children," adds Joseph Hurley, author of "The Best Way to Save for College - A Complete Guide to 529 Plans." "You can invest as little as $25 or as much as $250,000 for each child, and not worry about paying taxes on the gains as long as the funds are used for college." 
|
|
|
Track your stocks
|
Note: Pages will open in a new browser window
External sites are not endorsed by CNNmoney
|
|
|
|
 |
|
