How to spend your tax refund

(MoneyWatch) The best part of paying your taxes is probably getting your refund check.

According to the IRS, the average tax return last year was $2,899. According to a 2012 survey by TurboTax, many people say they are being responsible with their tax refunds: 42 percent plan to use the money to pay down debt and cover bills, and 25 percent plan to save it. But others are splurging: 15 percent of taxpayers plan to treat themselves to a vacation or shopping.

If you're one of the people lucky enough to get a substantial tax refund this year, be smart about how you spend it. Remember, even though it may feel like "found" money from an unexpected windfall, you earned that check by working hard -- the same as you do every other paycheck, so don't blow it on 2,899 lottery tickets.

Top priority: Pay off your credit card. It's far and away the smartest thing you can do.

Or take that money straight to the bank. Do you have a rainy day fund? Everyone should have at least three months' living expenses in a secure savings account.

Next: Maintenance work. Schedule those car repairs you've been avoiding -- new brakes, tires, a tune-up, oil change etc.

Or maybe you have house repairs to do? Use the money to pay for removal of storm-damaged trees and have some replacement trees planted with any leftover money.

Another great use of that extra money would be to open a mutual fund account or a Roth IRA if you qualify for one. The earnings grow tax-free, meaning you can reap the benefits in retirement without having to give a slice of the pie to Uncle Sam.

Remember, Roth IRAs are subject to income limits. If you file your taxes jointly with your spouse, your income needs to be below $178,000 for you to be able to fully contribute to a Roth IRA. If you make between $178,000 and $188,000, you are in the "phase-out" range and the amount you can contribute -- $5,000 in 2013 -- starts "phasing out." At $188,000 you are unable to contribute to a Roth IRA.

For people filing their taxes as singles in 2013, your income needs to be less than $112,000 to fully contribute to a Roth IRA, and your phase out range is between $112,000 and $127,000. It's one of the few times that earning less money actually works in your favor.

One final word to the wise: If you get a refund from the IRS, it means you paid more in taxes than you actually owed, in effect giving the government an interest-free loan. The IRS doesn't send you a check as a little "thank you" gift for filing your taxes -- they're just returning your money.

In the future, make sure you're claiming the right number of deductions on your W-4 or ratchet back the amounts you send in for quarterly estimated tax payments.

  • Mellody Hobson

    View all articles by Mellody Hobson on CBS MoneyWatch»
    Mellody Hobson is President of Ariel Investments, a Chicago-based money management firm that serves individual investors and retirement plans through its no-load mutual funds and separate accounts. Additionally, she is a regular financial contributor and analyst for CBS News and CBSNews.com.

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