If you are one of the many Americans that will pay lower taxes under the new tax rules, your natural inclination may be to spend the difference. While that might help the economy it might not help your long-term finances. Instead, consider one of these alternative ways to responsibly use up your tax savings.
Switch to a ROTH 401k or ROTH IRA— If you are already maxing out your 401k or IRA account, consider switching the savings to the ROTH option. Unlike regular 401k or IRA contributions, with ROTH contributions you cannot receive an upfront tax deduction on the money you contribute. But by using the ROTH option (and unlike the regular option), when it comes time to take the money out, it comes out tax-free, which could be a huge benefit when you reach retirement. And lucky for you — your taxes were just cut, so you can use the savings to balance out not getting that upfront deduction.
College Savings — if you have kids below age 18, chances are you are going to spend a ton of money sending them to college. You’ll be buying them food, books, computers — all the things you’re already buying them. The nice thing about a 529 plan is that you contribute money now, have it grow, and then take the money out tax-free to pay for qualified school expenses. It will be one of the few times in your life the government will give you a tax break for buying stuff for your kids (frozen yogurt at the college cafeteria included), so take advantage.
Modest home renovations— there are two types of home renovations — those that add a reasonable amount of value to your home relative to the cost and those that are total money pits. Avoid the money pits by renovating an area of your home with commercial value (outdated kitchens, bathrooms and garage doors come to mind). But create a modest budget and stick to it. If you do, you’ll end up adding equity to your home and also enjoy your spruced up home.
Donate— with the changes to the rules on itemized deductions, fewer people will deduct charitable donations on their returns going forward. If you will still itemize (a good conversation to have with your tax advisor), then upping your charitable giving is a nice way to lower your tax bill and give back to society. Plus, studies show that giving can be quite satisfying – donating money activates the pleasure center of the brain — the same area that gets activated by receiving money in the first place.
Before you run ahead with plans for vacations, new clothes and eating out, take a moment to think about how to use your tax savings to improve your long-term self. Doing so might be a little less fun, but can pay off handsomely down the line.
Jonathan Bernstein is a Senior Research Analyst within Hefren-Tillotson’s investment advisory group. Jonathan is a graduate of Yale College, a Chartered Financial Analyst charter holder (CFA) and a CERTIFIED FINANCIAL PLANNER certificant.