Tax refunds may be wonderful surprises to some people, and expected yearly “income” by others. Although a large percentage of Americans receive tax refunds, many quickly spend this money on big-ticket items, vacations, or other luxury purchases. It is common to see a rise in department and electronic store sales during the spring months due to tax refunds.

Although it may be tempting to spend that hard-earned money that was yours to begin with, there are a few things you could do with your tax refund other than spend it.

Change the Amount of Money Withheld

If you receive a tax refund, it means that you overpaid your taxes for the previous year. Since you gave the government too much money, it is now giving you back what was overpaid. In essence, you are loaning this money to the government. Although the government pays this money back, remember that it is interest-free.

Instead of overpaying your taxes, consider changing the amount that is deducted from your paycheck each month. To help you figure out what amount is best, use a withholding calculator like the one on the Internal Revenue Service (IRS) Web site. Just be careful to do the math correctly. If you withhold too much, you will end up having to pay taxes.

If you decide to withhold some of your income, consider putting this extra money into:

• A money market account
• A certificates of deposit (CD)
• Stocks and bonds.

Reinvest It

If you want the money from your tax refund to benefit you in the future, consider reinvesting this money. There are 2 good options:

• Individual Retirement Accounts (IRAs)
• Roth IRAs

Before deciding to invest in either type of retirement fund, understand the advantages and disadvantages of both.

Traditional IRAs have the following advantages:

• Contributions are tax deductible
• They are available to anyone

Traditional IRAs have these disadvantages:

• Withdrawal restrictions based on age
• Taxes are assessed on earnings when withdrawn
• Early withdrawal penalties

Roth IRAs have the following advantages:

• No age restrictions pertaining to withdrawal
• 100% tax free (based on rules and regulations)
• Withdrawals are not subject to penalties

Roth IRAs have these disadvantages:

• Monetary restrictions based on income
• Contributions are not tax deductible

For information regarding the differences between traditional IRAs and Roth IRAs, visit the Morgan Stanley Web site.

Make a Lump Sum Payment

If you receive a large tax refund, consider paying a lump sum toward a mortgage or an auto loan principle. This will help reduce the total cost of the loan, thus reducing the amount of interest you need to pay. It may also help lower your monthly payments.

Put the Money Aside for College

If you have children or plan to have children, and want to begin a college fund, consider using your tax refund for this purpose. If you open a college savings account prior to filing your tax return, the entire return can be directly deposited into this account.

If you are interested in opening a college savings account, research both 529 college savings plans and prepaid college savings plans.

For 529 College Savings Plans, consider these points:

• This plan will not guarantee a future rate for college tuition.
• The money in this plan may be used for any college expenses.
• There are no restrictions on age of beneficiary, residency, or enrollment.
• There may be a contribution limit.
• This savings plan is not guaranteed by the state.

For Prepaid Tuition Plans, think about these statements:

• This plan allows you to lock in a college tuition rate (available at select colleges and universities).
• The money in this plan may only be used for the purpose of tuition (separate plans may be available for room and board).
• Certain restrictions apply based on age of beneficiary, state of residence, and enrollment.
• Most plans are state guaranteed.

For more information regarding 529 College Savings Plans and Prepaid Tuition Plans, visit the Web site of the U.S. Securities and Exchange Commission.

If you do not have children, or are unsure if you plan to have children, you can use this money for your own education. Consider taking classes that will help you learn more about your field of employment. You may even be able to take a tax deduction next year for tuition.

Additional Resources

- Kiplinger Web site: http://www.kiplinger.com/features/archives/2007/01/eventintro.html

- IRS Web site: http://www.irs.gov/