5 Great Ways to Invest Your Tax Refund

I just received a huge tax refund in the mail, and I'm not sure how I should invest it (instead of just spending it like I usually do). Any suggestions?

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First of all, remember that a refund isn't a gift. It's an interest-free loan that you gave to Uncle Sam, and now he's paying you back. So consider adjusting your withholding so that your paycheck will be bigger, and you'll break even next tax time. Then set up an automatic payroll deduction plan (or deduction from your regular checking account) so that the extra money pours into a money market mutual fund. Even better, if you have a 401(k) retirement plan at work, step up your contribution by the extra amount that is showing up in your paycheck.

But getting back to the refund you just received -- here are some thoughts on how you can use it to better your financial position.

1. Begin an emergency savings plan
If you don't have a cash emergency fund set aside, put your tax refund in a money market mutual fund or a savings account.

2. Increase your 401(k) contribution
If you already have an emergency fund, you can use your refund to increase your 401(k) contribution at work. To do this, you need to deposit the entire refund in a savings account. Then if you've received a refund of $1,200, increase your 401(k) contribution from your paycheck to $150 a month. Your paycheck will decrease by about $100. (The 401(k) contribution is tax deductible, so about a third of your contribution comes from Uncle Sam's pocket, not your net pay.) Each month for the next 12, replace the $100 that would normally be in your net paycheck with $100 from the savings account where you deposited your tax refund.

3. Invest in an IRA
If you don't have a 401(k) at work or you are already contributing the maximum, you can use your tax refund to contribute up to $4,000 a year to a Roth or traditional IRA. As long as your income is below the limitations ($110,000 if single, $160,000 on a joint return), you can contribute to a Roth IRA. Otherwise, contribute to a traditional deductible IRA. If you aren't eligible for an IRA deduction (because you are covered under an employer retirement plan and your income is over $50,000), you could invest in an index equity mutual fund where taxes on most of the growth are deferred until you sell the fund.

4. Put money into a mutual fund
Other investments you might make with the tax refund include a good growth mutual fund.

5. Save for an education
Since education is always a good investment, you could also invest in an education IRA for your children's education. (You can contribute up to $2,000 per child.) You could use the refund to pay tuition for courses that will increase your future earning power as well.

And live it up a little too. But don't sacrifice your lifestyle for your savings. Set aside a portion of your refund (but no more than a third) to blow on something totally frivolous. That's your reward for being willing to save the rest of it. Happy saving!

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