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Smart ideas for your tax refund

Many Americans will get more than $2,000 back from Uncle Sam. "Today" financial editor Jean Chatzky offers tips on what to do with that money.

It seems like everyone is trying to get their hands on your tax refund. More than 200 million people will file taxes this year, and more than two-thirds expect to receive a refund, according to a survey from the National Retail Federation. To date, refunds are putting on average $2,344 back in Americans' pockets. That's up 3.6 percent from last year.

Retailers would like a chunk of that cash. So they're courting customers with incentives. For example, when you e-file your taxes through Turbo Tax, you can put part of your refund toward store gift cards and earn bonus dollars. But spending your refund is only one of the things (and not necessarily the wisest one) you can do with it. Here are the others in the order in which I'd recommend them.

Pay down high-rate debt. According to the NRF survey, nearly half of filers are planning to use at least some of their windfall to pay down debt. If you're like most Americans, you have a whole portfolio of debts — an average $9,300 in credit card debts alone, according to You get the best return by paying off those debts with the highest interest rates. So if you have a credit card at 24 percent and another one at 18, putting the money toward the former will save you significantly more over the long run.

And as the Federal Reserve continues to hike interest rates, the rates on your credit cards and other loans likely will climb even higher. That makes it more beneficial to pay off your variable rate debts today before they cost you even more money.

Build an emergency fund. For the first time since the Great Depression, Americans are spending more than they earn. Data released last week from the U.S. Commerce Department's Bureau of Economic Analysis reported that Americans had a negative 0.5 percent savings rate in January and February. That's a statistic you don't want to be part of. If you don't have an emergency cushion and a big emergency (think: layoff) hits, you may have to rely on your parents or government support. In the event of a smaller one (think: transmission) you'll likely float life on plastic for a while — and that can be a struggle to pay off later.

So use your refund to start building or add to an emergency fund. It should cover three months of living expenses for two-income households, six months for single-income households. Put the first three months of expenses in a liquid instrument like a money market account, and the rest in a three-month certificate of deposit, recommends Greg McBride, a senior financial analyst at Rates on many of these savings vehicles have greatly increased since the Fed began rate hikes in mid-2004. McBride says you should easily be able to find a money market account rate of 4.5 percent or better. HSBC is offering an online money market account with a 4.8 percent rate and minimum deposit of just $1. GMAC bank now offers a three-month CD that pays a 4.7 percent annual percentage yield, or APY, with a $500 minimum investment. You can search for other rates and details at

Up your retirement savings. You will get the most for your money by contributing enough to your 401(k) plan to get the full company match offered by your company. If that's not an option available to you, contribute to an individual retirement account (IRA). You have until April 17 to open a new Roth or traditional IRA or add to an existing account for 2005. You can contribute up to $4,000 for 2005, $4,500 if you're 50 or older.

Your savings can quickly add up — but starting sooner is significantly better. If you stash just $100 a month in a (non-matched) tax-deferred retirement account and the money earns an 8 percent return, 30 years from now you'll have $150,129. (If the money is matched at 50 percent, you'll have $225,194.) But, if you wait 10 years before you start saving — and only stash money away for a 20-year period — you'll only rack up $59,394 in the non-matched account and $89,092 in the matched one.If you are making an IRA contribution, there's no need to deal with anyone but your bank or brokerage firm directly. Last month, New York State Attorney General Eliot Spitzer sued H&R Block, the nation's largest tax preparation company, alleging that it steered hundreds of thousands of clients into IRAs that were virtually guaranteed to lose money because of hidden fees and low interest rates. You're always best off eliminating the middleman.

Reevaluate your deductions. If you're one of those Americans who gets a refund year in and year out, you should think about changing the amount withheld for taxes from your paycheck. By allowing the government to withhold more than you owe, you're essentially giving Uncle Sam an interest-free loan. The wiser thing to do is change your withholding amount and simultaneously open an automatic investment plan, or increase your 401(k) contribution to shuttle the money into savings. However, if you're one of those folks who manage to save little else each year besides that tax refund, then leave well enough alone. Losing a few dollars in interest by allowing the government to baby sit your savings is nothing compared to the price you pay by not saving at all.

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, .