Tax season is upon us and that means millions of households can expect a check from Uncle Sam in the coming months. According to the IRS, in 2010, the agency issued more than 119 million individual income tax refunds worth more than $358 billion total.
If you have money coming from the government, you may be thinking about squandering it on something impulsive. But you'd be wiser to make the most of that refund by using one of these strategies.
1. Build an emergency fund
Life happens. Pipes leak, arms break and car transmissions eventually give out. It's hard to get ahead financially if you are always scrambling to pay for the latest emergency. If you don't have a stockpile of easily accessible cash, don't spend your refund -- save it instead. Put it in an online savings account or a money market account where it can earn some interest and still be easily accessible.
At a minimum, you want to have enough in your account to pay for your homeowners, health and auto insurance deductibles. An emergency fund is generally considered fully funded when it has enough to pay for 3-6 months of living expenses. However, if you have a significant amount of debt, you may want to keep less in savings and focus on paying that down instead. Even the best high APY savings accounts can't earn enough to offset the interest being paid on most credit cards and personal loans.
2. Pay off debt
Once you have a little in savings, it is time to work on whittling down your debt. It may not be as much fun as a family vacation or a shopping spree at the mall, but eliminating debt -- particularly unsecured debt -- is one of the best steps you can take for the long-term health of your finances.
Not only does it free up money month to month, it also eliminates the risk of not being able to make those monthly payments should your income be reduced. That's not to mention that being debt-free can be emotionally freeing by eliminating those nagging worries about your bills. So use some of that tax refund to pay off the credit cards, the car or even make a dent on the mortgage.
3. Save for retirement
Financial analysts have been sounding the alarm for decades: In its current state, Social Security won't be solvent forever. While the government sorts out how best way to reform the system, take matters into your own hands by funding your own retirement account.
Put the money in a traditional IRA and, depending on your age and income, you could deduct up to $6,000 off next year's taxes. Select a Roth IRA if you think you might be in a higher tax bracket when you hit retirement. Money deposited in a Roth IRA is not tax-exempt, but it is tax-free upon disbursement, which can help you avoid a bigger tax burden later in life.
4. Start a college fund
Higher education means more income and better job prospects. Funding a college savings account for your child will pay dividends that far exceed those from any memories your toddler might make on a trip to see Mickey and the gang.
However, don't simply park the money in any old savings account. CD rates and money market accounts can't compare to the type of benefits offered by college investment funds such as 529 plans. Not only do you earn more interest with these plans, you also reap tax benefits. Some states offer tax deductions for contributions to approved plans, and 529 money can be withdrawn tax-free for most college expenses.
5. Take care of neglected maintenance
If you simply can't bear the thought of not spending at least part of your tax refund, put the money to good use by taking care of neglected maintenance issues. This doesn't mean renovating your kitchen just because forest green is so last year. Instead, it means taking care of those items that could potentially cost you more if not addressed.
For example, if you cross your fingers during every wind storm hoping the dead tree in back doesn't fall and hit the house, use your refund to take it down. Likewise, if you've never had a tune-up on your five-year-old car, it might be time to make that appointment.
It's tempting to think of a tax refund as a windfall of "fun money." But keep in mind it is your money that has been on loan to the government for a year. It should go without saying if you receive a large refund annually, you should consider changing your tax withholding. After you do so, direct deposit the extra money into a high APY savings account and let it earn money for you rather than the government.