Smart Ways to Use Your Refund

Looks like I'm getting a tax refund this year. What should I do with the money?

SLIDE SHOW: 10 Smart Uses for Your Refund

It’s rare to get a windfall these days. That may be one reason why so many people have so much more money than necessary withheld from their paycheck for taxes every year. The average refund has been around $3,000 for the past two years (most people receive their refund within three weeks of filing their returns). We usually counsel against giving Uncle Sam an interest-free loan (see below), but if you have a refund check coming your way, consider using it to bolster your personal balance sheet.

You could use the extra cash to make a dent in debt -- for example, to reduce high-interest credit card debt or pay down the principal on your mortgage. Or you could beef up your long-term savings -- say, by adding to your retirement savings in an IRA, or by helping your kids or grandkids save for college in a 529 account. You could rebuild your emergency fund or start saving for a down payment on your next home. Already have those basics covered? We have some other ideas:

Prepay your vacation. Set aside some money for vacation ahead of time. That will ensure that you pay off your credit card balance after you return and not accrue interest charges. Stash your refund in a separate account, then add money automatically every week (it’s easy to set up an online account for one of the money market deposit accounts listed on page 62; you’ll earn a bit of interest, too). You could also set up the account for other expenses -- such as a new car or holiday gifts.

Invest in your home. Your refund won’t be enough to redo your kitchen or bathroom, but it can pay for some smaller home improvements. Use the extra cash to add a backsplash, paint a room or cabinets, replace your bathroom sink, swap out your faucets, organize a closet, buy some shrubs or install a programmable thermostat. Here are 9 ways to add space and value to your home for $1,000 or less.

Load up on stocks. Use the extra cash to buy shares in a mutual fund or stock you’ve been considering -- but may feel is too risky for your IRA or not available in your 401(k) plan. For example, if you want to invest in small-company stocks vetted by a pro, check out a new addition to the Kiplinger 25, Homestead Small-Company Stock fund, which has a $500 minimum investment. Before you settle on individual stocks, consult our Stock Watch columns, including 16 Stock Picks for Risk-Averse Investors and 6 Tech Stocks for Dividends.

If your refund this year was substantial, consider giving yourself an immediate raise by adjusting your tax withholding to increase your take-home pay. Use our Tax Withholding Calculator to figure out how many allowances you should claim. (You’ll need to refer to your 2011 tax return.) Then ask your employer to give you a new Form W-4 to fill out.