Your 2011 tax refund from Uncle Sam may have recently shown up in the mail or, more likely, directly in your bank account. Time for a vacation or that new gadget? Though it’s tempting to use your refund for lots of different things, look at it this way: That refund could actually be the meal ticket to a secure retirement – something, frankly, many young entrepreneurs today aren’t guaranteed.
Many business owners are hungry for extra cash – both to invest in their business or to finally be able to pay for stuff they haven’t had the spare cash for. But with the economy in turmoil, questions about the future of Social Security and Medicare retiree benefits programs and so many other uncertainties about the future, saving up for retirement while you’re still young is one of the best things you can do for yourself. Of course, every young CEO hopes their business will someday bankroll their retirement dreams. But realistically, that doesn’t happen for everyone. And you need to have a safety net in case it doesn’t.
Here’s a look at how investing that tax refund can pay you back in spades.
According to the IRS, the average federal tax refund today is about $3,000. So, let’s just assume you got a check back from Uncle Sam for that amount.
You took that $3,000 check and you put it in your Roth IRA, so that it can grow and be withdrawn free of income taxes. Inside your IRA you keep your money in various stock and bond mutual funds. (Having a diversified investment portfolio, after all, is a great way for business owners to protect themselves in case something happens to themselves or their business.)
Let’s say that your Roth IRA generates an average annual return of 6% over the next 40 years. (A 6% average return is a pretty safe bet for a diversified portfolio over a long period.) If you just took today’s $3,000 tax refund and put it in the Roth, it would become almost $31,000 after 40 years. Thanks to the magic of compounding investment returns, that original amount grew 10 times.
OK, that’s nice, but you’re not going to live the good life off $31,000.
But if you took today’s $3,000 check – and invested every $3,000 tax refund check you receive for the next 40 years – you’d have $523,000 in the end. That probably also won’t fund your retirement dreams, but it’s a noble step in the right direction. And it’ll help protect you and your family in the future, regardless of what happens. You’ll be far ahead of many people your age.
If you can put away more than $3,000 each year for the next 40 years, you’ll be in great shape.
The bottom line: Getting in the habit of saving and investing your tax refund in an IRA or a retirement plan for self-employed individuals – such as a solo 401(k) or SEP-IRA — can give you a major financial boost and provide you some financial security. Entrepreneurs need that financial security because they often don’t have the luxury of 401(k) savings, pensions and other benefits offered to the “working crowd.”
Kelly Spors writes for RothIRA.com, a leading retirement and Roth IRA resource. A former Wall Street Journal reporter, Kelly has written about small business and personal finance for The New York Times, Entrepreneur magazine, Yahoo! and SmallBizTrends.com.Subscribe to the Podcast