5 Smart Uses for Your Tax Refund

Use the influx of cash to improve your financial situation.

I just filed my taxes and will be getting a pretty big refund. What’s the best way to use the money?

In a year when raises and bonuses at work are rare, getting a tax refund may be your one big chance to put extra money toward improving your financial situation. Here are five smart ways to use your refund:

Pay off high-interest credit-card debt. Many credit-card companies boosted interest rates in anticipation of the new credit-card law, so carrying a balance may now cost you more than it had in the past. And the new law requires card companies to clearly disclose how long it will take you to pay off that balance -- and how much you’ll pay in interest -- if you make only the minimum payment every month. Those numbers can be shocking.

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Using your refund to pay off a balance with an 18% interest rate is like earning 18% on your investments -- an incredibly valuable use of the money. And if you pay off your balances, you can afford to close some cards that are now charging high fees. For more information about the new credit-card laws, see FAQs on the New Credit-Card Rules, More Credit-Card Fees Coming and Close a Credit-Card Account to Avoid Fees.

Rebuild your emergency fund. Many people had to raid their emergency fund over the past year and had little extra money to restore it. You could use your refund to start rebuilding that fund, which can help you avoid landing in credit-card debt if you have an emergency. Try to keep at least six months’ worth of essential expenses in this account, or more if you think your job -- or your spouse’s -- is in jeopardy. Keep the money easily accessible in a money-market account or savings account that earns interest. See Why You Need an Emergency Fund for more information.

Boost your retirement savings. You have until April 15, 2010, to contribute up to $5,000 to an IRA for 2009 (or $6,000 if age 50 or older). If your modified adjusted gross income is $120,000 or less if you’re single, or $176,000 or less if you’re married filing jointly, then you can contribute to a Roth IRA, which lets you withdraw the money tax-free in retirement.

If you earn too much for a Roth, you can contribute to a nondeductible traditional IRA, then immediately convert it to a Roth. See our Roth Conversions for Everyone special report for more information. If you’ve already made your 2009 contribution, put the refund money in your account for 2010 to jump-start your contributions. You can always add more money later in the year.

Build your college savings. It’s always hard to juggle saving for college and retirement. Here’s an opportunity to use your extra money to contribute to a 529 account. You’ll be able to use the money tax-free for college bills, and you could get a state income-tax deduction for your contribution. See The Best 529 College-Savings Plans for details.

Help your kid save for the future. If you’ve covered all of those bases, you can use the extra money to contribute to a Roth IRA for your child. Your kid is eligible as long as he or she has earned income for the year. Your child can contribute up to $5,000 or the amount of his or her earned income for the year, whichever is lower, and you can give him the cash to do it. The deadline for 2009 contributions is April 15, 2010. See Why Your Kids Need a Roth IRA for details.

Here’s something to consider: Wouldn’t it be better to have more money in each paycheck rather than wait for a refund? Use our Tax Withholding calculator to see whether you can adjust your withholding and get more money in each paycheck right away.

If you’re wondering where your refund check is, see How to Track the Status of Your Refund.

Kimberly Lankford
Contributing Editor, Kiplinger's Personal Finance

As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.