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Get The Most From Your Tax Refund

Author: Andrew Smith

While many Americans abide by a strict budget each month, tax season is the one time each year when the typical filer can expect a sudden influx of cash. According to the IRS, the average taxpayer received a refund totaling $2,918 in 2014.

To be sure, it's tempting to use that money on something fun, like a posh vacation or state-of-the-art TV. But before you blow that refund, think of your long-term financial needs; wads of extra cash don't rain down on most of us that often. Here are some alternative ways to spend your refund check that might prove more useful in the long run.

1. Pay down debt

Tax season is the perfect time to get rid of debt. Unless you're borrowing at an extremely low cost, this should probably be a priority over pursuing investments.

Why? Because you're usually putting your money to better use by tackling high-interest debt, such as credit card balances. Say you're paying 15% interest to your card issuer. Reducing that balance is akin to receiving a 15% return on a stock or bond. That's an opportunity any smart investor would jump at. For more thoughts on this, read To Invest Or To Reduce Debt, That's The Question.

2. Build Up Your Emergency Fund

Sadly, you don't always know when something unfortunate is going to happen, like the loss of a job or an operation your insurance doesn't fully cover. That's why most financial planners suggest you maintain an emergency fund that can pay anywhere from three to six months' worth of expenses.

If your just-in-case fund is a little shy of that mark – or non-existent – a tax refund is your chance to build or enhance it. Does this provide the immediate satisfaction of a Mai Tai on the beach? Not exactly. But there might come a day when you'll be very glad you thought ahead.

3. Kickstart a 529

The cost of attending college these days is pretty frightening, although 529 plans make it a little easier to start saving. As long as withdrawals are used for tuition, fees, books, computer equipment or room and board, you won't have to pay capital gains tax on distributions from the account.

Even though the beneficiary can be someone other than yourself, such as a child or grandchild, you usually don't have to worry about a federal gift tax when you give to a 529 account. That's because total gifts to another individual, including contributions to a college savings plan, would have to exceed $14,000 per year before triggering the tax. For more on the ins and outs of these plans, see 529 Risks To Take (Or Not).

4. Boost Your IRA

As long as you've maxed out any matching funds that your employer kicks into your 401(k), you might consider setting up an IRA to give your retirement savings a boost. Though both types of accounts offer tax advantages, IRAs provide added flexibility because you're not confined the funds in your company's plan. In 2015, individuals are allowed to put up to $5,500 per year into an IRA, or $6,500 if you're age 50 or older.

With a traditional IRA, you contribute pre-tax dollars and then pay ordinary income tax on the any withdrawals in retirement. But you can also select a Roth version, which lets you invest post-tax money now in order to avoid any tax liability on qualified distributions later on.

5. Spruce Up Your Home

One of the smartest uses of your tax refund is renovating your home or doing preventative maintenance. If you have a roof that's beginning to show its age or drafty windows, paying them off with the help of your Treasury check is good way to avoid putting the complete bill on a credit card.

The HouseLogic blog suggests using part of your refund to obtain a thorough energy audit, which typically runs between $400 and $600. These tests rely on sophisticated equipment to identify places where hot or cold air can escape your home. That way, you get the most bang for your buck when making energy-related improvements to the property. For more on investing in a renovation, see Home Improvements That Really Pay Off.

The Bottom Line

There's nothing wrong with treating yourself to something nice with your tax refund. But those who use the bulk of the money for long-term needs are usually happy they did.

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