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How to make prudent use of your tax refund

Before you plunk down big bucks on a

Before you plunk down big bucks on a flat-screen TV or take that big vacation, consider some investment opportunities. (April 11, 2013) Credit: Bloomberg

Americans love getting a tax refund. The IRS says 80 percent of taxpayers received a refund last year. The average refund was more than $2,700.

What's not to like about found money?

But a refund is really just the return of a yearlong, interest-free loan that you extended to your spendthrift Uncle Sam. This year, make sure that you keep that money and put it to work. Before you plunk down big bucks on a flat-screen TV or take that big vacation, consider the following investment opportunities:


Replenish emergency reserves

Before retirement, you should always keep six to 12 months of living expenses in a safe place, like checking, savings or money market accounts. If you are already retired, it's advisable to double that amount.

For one reason or another, you may have dipped into your emergency reserve funds over the course of the year. Uncle Sam's refund check can help replenish those accounts.

With interest rates still at rock-bottom levels, explore CDs and I-bonds to boost the income on your emergency reserves. Check out deposit for help.


Pay down credit card, auto and maybe mortgage debt

Your refund is an excellent way to put a dent in your outstanding debts. The bonus is that when you pay down debt, you are essentially earning a guaranteed return that is likely much higher than any investment available.

For those who are risk-averse, consider paying down your mortgage. Even though your rate may be low, it's probably higher than whatever you are earning on your cash equivalents.


Retirement contributions

If you are still working and have access to an employer-sponsored retirement plan, like a 401(k), a 403(b) or a 457 plan, increase your contribution amount for 2013. Because you have that 2012 refund in the bank, you can afford to absorb the extra money coming out of your paycheck.

The 2013 pretax contribution limit for employer plans has increased to $17,500, and the limit for over-50 catch-up contributions is $5,500.

You can also use that extra money to get a jump on funding an IRA or a Roth IRA for tax year 2013 right now. The maximum you can contribute to all of your traditional and Roth IRAs is the smaller of: $5,500 ($6,500 if you're age 50 or older), or your taxable compensation for the year.

Note: Even if you have an employer-sponsored plan, you may also qualify for the full annual IRA deduction. Check the IRS website for details.


Invest in a non-retirement account

If you have maxed out your retirement accounts and still have extra money, consider opening a non-retirement investment account with a no-load mutual fund company like Vanguard, T. Rowe Price or Fidelity, or go to a discount brokerage firm like Charles Schwab or TD Ameritrade.

Don't be tempted to purchase actively managed mutual funds: According to research, over the 23 years ending in 2009, actively managed funds trailed their benchmarks by an average of one percentage point a year. Another report from S&P found that most actively managed funds waged a losing battle over the five years through Dec. 31, 2010.

Fund 529 plans

Is someone in your family struggling to save for college? It's not surprising, since the cost of college tuition has spiked 300 percent since 1990. If you are interested in giving the gift of education, then consider funding a Section 529 college savings plan. The money you deposit in a 529 plan grows tax-free, and withdrawals that are used to pay for qualified college expenses sidestep taxes, too. You can invest up to $14,000 in 2013 without incurring a federal gift tax. There are some states -- including New York -- that offer state tax benefits as well, so be sure to research the options at savingforcollege .com.

Of course, if your financial house is in order, it really is OK to blow the refund and have some fun, too!

Jill Schlesinger is editor-at-large for She welcomes emailed comments and questions.

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