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updated 4/16/2007 8:30:04 AM ET 2007-04-16T12:30:04

Yes, it's tax time. The good news is refunds are about 6 percent over this time last year. So far, the IRS has processed refunds for nearly 39 million taxpayers to the tune of $102 billion. That works out to an average of $2,650 per refund. Sounds like a bundle? Well, one thing you need to understand about tax refunds is that they're larger earlier in the season — that's because people who know they're getting money back have an incentive to file, rather than leaving their hard-earned cash in the coffers of Uncle Sam.

The big question is: What do you do with all that dough? My suggestion. Something good for yourself. Sure, you may feel a need (or at least a desire) to splurge a little bit. We'll talk more about that in a minute. But just take a look at the good you could do for your life, your finances, your psyche or all three by taking any of the following suggestions:

  • Make an IRA contribution. For a while now, we've been telling people to file electronically and have their refunds direct deposited. This is the way to get money owed you back inside of two weeks. This year, for the first time, the IRS is allowing you to direct deposit your refund not just into a bank account, but into an IRA, a Roth IRA, a SEP IRA (for self-employed individuals), a health savings account or a Coverdell education savings account.

    You can also split the refund and deposit it in a couple of accounts at the same time. To do this, you'll need IRS form 8888, which is new, but like all forms available at IRS.gov. A couple of caveats. If you are using your refund to make your IRA contribution make sure you let the custodian of your account — the brokerage firm or bank — know what year the contribution is for. And if you intend the contribution to be for the 2006 year, don't delay. If the refund doesn't arrive until after April 17, it will only be able to be counted for the 2007 year. I am a huge fan of this. And here's why:  

    EXAMPLE: A 30-year-old puts $2,650 in an IRA and invests it in stocks. The money grows at 8 percent a year. At age 65, it will be worth $43,175. Make the same contribution every year and you'll have $531,434 at retirement.


  • Pay off debt. Think of it this way: When you use your refund to pay off debt at a particular rate — like 15 percent or 20 percent or 25 percent —and you get the equivalent of a 15 or 20 or 25 percent return on your money. The higher the interest rate you're paying on your debt, the more it makes sense to use the money to pay it down.

    EXAMPLE: Pay off $2,650 on a credit card charging 20 percent interest. Save $530 in interest a year. Start an emergency fund. An emergency cushion is KEY to staying out of debt. If you have savings you don't have to charge it if the transmission goes, if your roof leaks, or when your quarterly insurance premium is due.

    EXAMPLE: Put your $2,650 in a savings account earning 5.3 percent. Earn $140 in interest a year. Make an extra mortgage payment. Make one extra mortgage payment a year and you'll cut the term of a 30-year fixed rate mortgage to roughly 24 years. That's hugely helpful, particularly if you are going into retirement with a mortgage.

    EXAMPLE: $2,650 is the mortgage payment on a $442,000 30-year fixed rate loan at 6 percent. Over the loan, pay $512,000 in interest. Make one extra payment this year (once) and you'll save $12,000 over the life of your loan and shorten the term of your loan by five months. Make one extra payment EVERY year and you'll save $104,000 in interest over the life of your loan and shorten the term of your loan by five years.


  • Do something for your psyche. $2,650 could pay for a course that refreshes your career skills, a year's membership at a great gym, 18 to 20 sessions with a life coach, or a basic estate plan (including wills, basic trusts, health-care proxy, living will and a sizable term life insurance policy). Making a contribution to charity is also great for your soul — givers tend to be happier people overall, whether they are giving money, giving time or giving away old things. Just remember that this year items that you give away have to be in good enough condition that you'd be equally likely to hand them down to a family member or friend.


  • Need a splurge? Split the difference.  If you're just dying for a few days on the beach, a spring wardrobe, a plasma television — well, chances are I'm not going to be able to talk you out of it. But maybe I can talk you into splitting the difference. $1,325 could: earn you $21,587 in an IRA by retirement; save you $265 in credit card interest; earn you $70 in a savings account; and make you feel like you did something GOOD with your money.


  • FINALLY. Change your withholding. This exercise is a lot of fun. But you'll put more money in your pocket over the long haul by NOT giving Uncle Sam an interest-free loan to begin with. So, change your withholding and then start automatically funneling an equal amount into your choice of savings vehicle — or to pay down your debt or your mortgage throughout the year rather than once a year.

Jean Chatzky is an editor-at-large at Money magazine and serves as AOL's official Money Coach. She is the personal finance editor for NBC's "Today Show" and is also a columnist for Life magazine. She is the author of four books, including "Pay It Down! From Debt to Wealth on $10 a Day" (Portfolio, 2004). To find out more, visit her Web site, www.jeanchatzky.com.

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