How to Save Your Tax Refund for Retirement

Emily Brandon
U.S.News & World Report

If you're expecting a tax refund this year, consider saving at least a portion of it for retirement. Depositing your tax refund in an individual retirement account could make you eligible to claim a tax deduction on your current or a future tax return. You won't have to pay tax on your IRA contribution until you withdraw the money from the account. Here's how to save your tax refund for retirement:

[Read: How Saving in an IRA Can Reduce Your 2016 Tax Bill.]

Set up a direct deposit. IRS Form 8888 allows you to directly deposit your tax refund into two or three different accounts, including a traditional IRA, Roth IRA, SEP-IRA or myRA. "When you file your return and you are entitled to a refund you can direct that the Treasury send your money directly to the custodian or trustee of the IRA," says Barbara Weltman, an attorney and author of "J. K. Lasser's 1001 Deductions and Tax Breaks 2017."

Consider the tax breaks. Contributions to a traditional IRA are tax deductible and could be used to reduce your 2016 or 2017 tax bill. Income tax won't be due on your IRA deposit until you take a distribution from the account. "Someone with a $35,000 salary who pays roughly 25 percent in income taxes, if they were to contribute 6 percent or $2,100 to their IRA, they would be taxed only on $32,900, which means their taxes would be $525 less," says MaryAnn Monforte, a professor of accounting at Syracuse University's Whitman School of Management. "You're getting about a quarter of that contribution back in tax savings. I think it's a great way to use your tax refund because you weren't counting on that money anyway." Saving in a Roth IRA or myRA won't get you an immediate tax deduction, but the account will grow without being taxed, and withdrawals in retirement are likely to be tax-free.

[Read: 3 Little-Known Retirement Savings Tax Breaks.]

Specify which year the contribution should be applied to. If you contribute to a traditional IRA between Jan. 1 and April 18, you can choose whether the contribution will apply to tax year 2016 or 2017. If you don't tell the plan administrator which year to use, the contribution might be automatically applied to the calendar year when it was received. "Make sure that the custodian knows the tax year that you want it applied to," Weltman says. IRA contributions that will qualify you for a tax deduction on your 2016 tax return are due by April 18, 2017. Deposits received after that date will be automatically applied to tax year 2017.

You can claim an IRA deduction before the money is in the account. You can file a tax return claiming a tax deduction for a traditional IRA contribution before making the deposit. "Your tax return can show a contribution to the IRA that you haven't made yet," says Gil Charney, director of The Tax Institute at H&R Block. "If you file your return in February and you have a $5,000 refund, you can take that refund and fund the IRA." You don't need to make the IRA deposit until the due date for your tax return. However, if the deposit isn't initiated by your tax filing deadline, you will need to file an amended 2016 tax return without the IRA deduction and pay any additional tax you owe.

Pay attention to the contribution limits. You may be eligible to contribute up to $5,500 to a traditional IRA, Roth IRA or myRA in 2017. The contribution limit jumps to $6,500 for those age 50 and older. But the ability to make Roth IRA contributions is phased out for people whose modified adjusted gross income is between $118,000 and $133,000 as an individual or $186,000 to $196,000 for married couples. If you deposit too much in a Roth IRA, a 6 percent excise tax is applied to the excess contributions. If you have a 401(k) or similar type of retirement benefit at work, traditional IRA eligibility phases out when your modified adjusted gross income is between $62,000 and $72,000 ($99,000 to $119,000 for couples). There are higher income limits for couples if only one spouse has access to a 401(k) at work.

[Read: How to Claim the Retirement Saver's Credit.]

Your tax refund can also be directly contributed to a variety of other types of savings and investment accounts. While it is common to have a tax refund deposited in a checking account, other eligible accounts include a health savings account, an Archer MSA, a Coverdell Education Savings Account and a TreasuryDirect online account. You can also use your tax refund to buy up to $5,000 in paper or electronic series I savings bonds. "Fill out Form 8888 to make the contribution directly," Charney says. "If you don't put it in your checking account, you are not tempted to spend it."

Emily Brandon is the author of "Pensionless: The 10-Step Solution for a Stress-Free Retirement."

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