How to Invest Your Tax Rebate

ByMellody Hobson <br> Third in a Series

N E W Y O R K, July 20, 2001 -- Starting next week, the government is mailing out 91 million tax rebate checks worth $38 billion, leaving Americans with an unexpected windfall of several hundred dollars apiece.

Under the tax-relief package signed into law last month by President Bush, the rebates range from $600 for married taxpayers to $300 for single taxpayers, based on income level.

When Will I Get My Rebate?

The White House and many retailers would love it if people cashed the checks and headed to the local mall to spend the whole loot. Some stores, including Wal-Mart, are offering to cash their customers' refund checks, free of charge, with the hopes that they will end up spending money in the store.

Other retailers are timing promotions and discounts to coincide with the rebates to encourage customers to spend them. But Good Morning America's financial contributor Mellody Hobson, of Ariel Capital Management, says there are smarter things to do with the money.

Here are her five suggestions:

Pay Off Credit Cards: Although it would be tempting to run out and buy a digital camera or a DVD player, a smarter move would be to pay off credit card debt, Hobson said.

If you make the minimum payments on a $1,000 balance, you will continue to carry the debt for almost eight years. But if you take your $300 refund and put it toward your credit card bill, you can pay off that bill in three and a half years and save $562 in interest.

Open an Education IRA: You don't have to be a parent to open an educational IRA. It can be for nieces, nephews, grandchildren, godchildren or good friends, perhaps given as a present for a baby shower or a birthday.

If you contribute your $300 tax return into an educational IRA for a one-year-old today, that $300 will be worth $2,060 when the child turns 18, assuming a 12 percent average annual total return.

Under current law, the maximum contribution for these accounts cannot exceed $500 a year and must be made before the beneficiary reaches age 18. But a new law that goes into effective in Jan. 1, 2002, allows a $2,000 contribution each year per child.

Buy a Stock:

Another option is to try investing in the stock market.

One might think that $300 to $600 is too nominal an amount of money to make a difference in investing. But time is the greatest asset in the stock market, and you can earn meaningful results from what may seem to be an insignificant amount of money, Hobson said.

She suggests investing in small cap value stocks, which historically have returns at 12.4 percent. If a 25-year-old puts their $300 tax return in a small cap value stock, it would be worth $10,003 by the time they retire at age 55.

For couples who choose a small cap value stock and hang onto it, a $600 tax refund will be worth $20,005 in 30 years.

Spread the Wealth: Give your $300 to charity, Hobson suggested.

Philanthropy is a win-win situation. Not only do you feel good about giving to a good cause, but the government rewards you with a small break on your taxes.

A single person with $40,000 in taxable income who decides to donate their $300 refund to charity would see an $84 break on next year's taxes.

That doesn't include additional state income tax benefits that the person would receive. To get the benefit, though, they must itemize.

Save for Holidays: Although Christmas may be the last thing on people's minds now, Hobson recommends socking the tax rebate away for holiday gifts.

In 2000, the average American household spent $828 for Christmas, and most people end up charging it to a credit card. If you pay the minimum amount, it would take five and a half years to pay off and rack up another $475 in interest. So if you put that $300 tax rebate aside, just in a savings account you will not feel as strapped when the holiday season comes, Hobson said.

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