Eight smart ways to use your tax 'windfall'

by Andrew Housser

This spring marks an especially rewarding -- and therefore potentially risky -- season for taxpayers who anticipate receiving a refund from the Internal Revenue Service. In addition to tax refunds that averaged $2,287 last year, most Americans will be receiving economic stimulus checks - up to $600 for individuals and $1,200 for couples.

Smart taxpayers will remember that this money is not just a windfall. A tax refund is a return of your own money that the government claimed for you this past year. And the economic stimulus checks are also returned taxpayer dollars.

Americans receiving substantial amounts back from the federal government have the opportunity to make a real difference in their financial picture. Here are eight great ways to make use of your tax and stimulus dollars:

  • Pay down credit card and other high-interest debts (including payday loans). About 20 percent of all credit cards are "maxed out" by their owners, but applying your refund and economic stimulus check - nearly $3,000 for many - to the highest-interest-rate balance will start you on your way to debt freedom. As a bonus, you will improve your credit rating, which is affected by the amount owed relative to available credit balances.
  • Build a cushion. An emergency fund should include 6-9 months' living expenses (not necessarily salary, but the amount of money you would need to scrape by). But even $1,000 can provide a cushion so you do not have to turn to credit cards or payday loans to cover unexpected expenses. Store these savings in a money market fund or rolling CDs so that the money earns interest and cannot easily be spent -- but can be accessed in an emergency.
  • Make sure you are adequately insured. Everyone should have health, auto and home or renters' insurance. If dependents rely on your income, look into life insurance. Consider an umbrella policy to protect from additional liability. And if you could not live without your income, purchase disability coverage. A $3,000 tax boon could pay for a whole year's life, auto, and renters' - and/or umbrella - insurance for most people.
  • Fund the future. Contribute to retirement savings, whether an individual or Roth IRA, 401(k) or other plan. If the program is tax-deductible, you will be helping next year's tax picture, too.
  • Get educated. Put the money toward a college savings plan for your child, or strengthen your own financial future by continuing your education. If you receive the full $3,000, that money could pay for a good portion of an associate's degree. Higher education can really pay off: On average, associate's degree holders earn 23 percent higher salaries than high school graduates; holders of bachelor's degrees earn even more.
  • Refinance your mortgage. If your mortgage interest rate is high, or adjustable and climbing, $3,000 can cover all, or most, of the costs of refinancing into a lower-interest mortgage if your credit is good enough to do so. You will save thousands more in interest charges -- and avoid rising payments that could risk your home.
  • Invest in your home. If you own your home, consider using your refund to cover major or minor maintenance to make sure no bigger (and more expensive) problems arise down the road. In addition, these capital improvements can create equity.
  • Adjust your withholding. Finally, talk to your employer about adjusting withholding so that next year, the government does not keep your money -- you do. Instead of giving the government a loan all year, use the extra cash in your paycheck to invest in extra mortgage payments, retirement savings or repaying debt.

Most importantly, use a tax "windfall" to invest in your future, not in a flashy lifestyle. You will thank yourself today and in future years.