5 slam-dunk uses for your refund

Tax refunds are up this year, topping $2,500 on average. How will you use yours?

By Jeanne Sahadi, CNNMoney.com senior writer

NEW YORK (CNNMoney.com) -- So far this tax season, the average federal tax refund that taxpayers are getting is $2,548.

That's by no means a king's ransom, but it's enough to help you live life as something other than a serf, if you use it well.

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For starters, don't think of it as found money. It's not - it's been yours all along. You just ended up overpaying the IRS all year. And don't think Uncle Sam will be paying you any interest even though he's had use of the money for up to 12 months.

But you could think of your refund as forced savings. You've lived all year without the money, so barring any more-immediate emergency needs, you should continue to lock it up but you should make it work for you.

Or it may be that the money would be put to better use dispensing with some or all of your high-rate debt.

In either case, you can do a lot better with your cash than the IRS.

Here are just five ideas as to how:

Fund your IRA

Whether you have a Roth or a traditional IRA, you're allowed to make up to a $4,000 contribution ($5,000 if you're 50 or older) for tax year 2006 through April 17 this year. Or, if you can't make that deadline, you can make your 2007 contribution with it.

Here's a rundown of the key differences between a deductible IRA and a Roth IRA, as well as Money Magazine's best savings strategy.

Fund a 529

Socking money away for a child's college education is one of the harder financial demands of parenthood. But at least in a 529 you may get a tax deduction for your efforts.

Some states offer an income tax deduction to residents for contributions they make to a 529 plan. To see if yours does, visit SavingForCollege.com.

Open a CD

If you're going to need money - say, for a down payment on a home or car - in the next year-and-a-half or two, you might opt to put your refund in a 1-year CD. Rates have been pretty favorable - averaging 5.4 percent of late, which is about double the rate of inflation.

You don't need to just stick with your own bank for one of these, either. There's a lot of competition for your money from banks across the country and from Internet-based banks which are FDIC-insured, meaning you're protected on losses up to $100,000 if anything happens to the bank.

"You can get a substantial difference in yield if you're willing to go out of state," said Greg McBride, senior financial analyst at Bankrate.com.

Check out the Loan Center for a comparison of specific banks' CD rates.

Add to your emergency fund

There's nothing less fun - or harder to save for - than a rainy-day fund worth three months of your expenses to protect you if ever you're laid off or face a large unexpected expense like a broken down car or furnace.

The best place to house your emergency fund: a high-yield savings account. They're slightly different than money market accounts in that they typically don't offer check-writing capabilities, but they also don't limit your number of transactions as money market accounts can, McBride said.

And at least at the moment, some - like Citibank's e-savings account at 4.75 percent or HSBC's DirectEveryday account at a promotional 6.00 percent for new accounts through April 30 and 5.05 percent thereafter - are offering more favorable rates than your basic money market account, which is averaging a 3.7 percent yield.

Reduce your credit card debt

If you're carrying high-rate debt - defined as a rate higher than any rate you're getting on your savings accounts - reducing or eliminating your balance sooner rather than later can save you a bundle long-term.

If you want to put your refund to use in more than one way, the IRS is now offering a split-refund option, which lets you designate up to three accounts at financial institutions into which you want the IRS to direct deposit portions of your refund.

To activate this option you'll need to fill out Form 8888 and send it in along with your tax return.


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