Using Newfound Tax Money Wisely

(CBS)  Starting this week, you should notice a few more dollars in your paycheck.

As part of the administration's economic stimulus plan, employers will be withholding less income tax.

Many people are also getting their tax refunds right around now.

So, on The Early Show Thursday, resident financial guru Ray Martin offered suggestions on what to do with the additional green coming your way.

According to Martin:

Uncle Sam wanted to give all workers some cash as part of the stimulus push. Rather than spending millions of dollars to print and mail paper checks, officials decided to change tax withholding formulas to allow everyone to see a few more dollars each week -- singles will likely see $10 to $15 per paycheck if paid weekly; those who are married filing jointly may see $15 to $20.

Officials also figured that, if people were having a hard time paying their mortgages or other bills, it would be much more helpful for them to get more pay period than to receive one lump sum down the road.

That sounds pretty straightforward, but it gets a bit tricky:

The additional money now is in anticipation of these workers being able to claim the "Making Work Pay" tax credit next year, on their 2009 tax returns. Think of this as an advance of money now that you will be eligible to receive next April.

When you do file your 2009 tax return, eligible workers will be able to claim the new tax credit; the credit is available to those with earned income and will be up to $400 for single filers and $800 for joint filers. The full credit will be paid to people with modified adjusted gross incomes of $75,000 or less ($150,000 per couple). A partial credit would be paid to those making above those amounts but no more than $95,000 ($190,000 for couples).

If you don't meet these income requirements, you'll essentially have to "pay back" some of the money that's now appearing in your paycheck. Or, if you receive a tax refund, it will simply be smaller.

This is also a good time to assess tax refunds in general.

The average refund is nine percent higher this year than last -- $2,896, according to the IRS. That's probably a result of changes in tax laws, such as higher contribution limits for IRAs, tax credits for certain homebuyers, etc.

But I continue to pound home the point that it's NOT a good idea to receive a large tax refund. Getting a tax refund is nothing to brag about. You're getting the money back because you gave the IRS too much of your income out of each paycheck in the previous tax year. That's giving an interest-free loan to the government because you overpaid your taxes. Would you overpay your cable TV bill so you could get a refund of the overpayments a year later? I don't think so.

Basically, you can create your own economic stimulus tax cut and increase your take-home pay each week by changing your tax withholdings. That will result in more money for you to spend now, and a smaller tax refund down the road.

But if you're one of those people who received or will receive a tax refund this year, what should you do with that money? Three thousand bucks is nothing to sneeze at, particularly in this economic climate.

You want to be smart with every penny, so what are the best options for this cash?

The standard answer is to put the money toward paying off high-interest debt, such as your credit cards.

While that's still a good idea, it's more important than ever right now to have a sizable emergency fund in case you lose your job. While nobody ever thinks it will happen to them, you'd better believe you'd be happy to have six months' worth of expenses tucked away if it were to.

In the past, I've always suggested that folks have three-to-six months' worth of expenses on hand; now I suggest six-to-12.

Where to put this money? Any insured money market account is a good choice -- the money will be protected, and will earn a higher interest rate than it would in your checking account. Whatever you do, make sure the account you choose does NOT have a debit card or ATM card attached to it: If the money is easy to access, you'll be tempted to do just that.

Other good options for the money include:

Contributing to an IRA/401(k): Stocks are "on sale" right now! Don't be hesitant to put your money into the market.

Investing in yourself: Again, nobody wants to think about losing his or her job, but it's better to be prepared than not. Think about taking a class or learning a new skill that might help you in a job transition or in the job hunt.

Making an extra mortgage payment: By making just one additional payment on a 30-year mortgage each year, you can have the mortgage paid off in about 20 years and save thousands of dollars in interest over that time.