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By Jason Stipp and Christine Benz | 04-18-2012 01:00 PM

Where to Invest Your Tax Refund Check

Get a refund priority checklist and a few fund ideas from Morningstar director of personal finance Christine Benz.

Jason Stipp: I'm Jason Stipp for Morningstar.

Tax season is finally over, and if you're among those lucky enough to get a tax refund, you may be wondering what to do with that small "windfall." Morningstar's Christine Benz, our director of personal finance, has a few ideas to use that tax refund smartly. Christine, thanks for joining me.

Christine Benz: Jason, great to be here.

Stipp: One of the first things that you will want to do when you get that refund is,  look at the size of it. The size of that refund may be telling you something?

Benz: It may be. It may be telling you that you are withholding too much, and giving the IRS an interest-free loan. So, if you are getting a very large check back, really take a look at your withholding and think about adjusting that so that you aren't withholding so much and that you won't receive such a big refund next year, but you also won't be giving the government that loan all year long.

Stipp: So hopefully you'll get a little something back instead of owing, even if you've kind of optimized that withholding. There are a few different ways that you might think about using this money. You might not want just go out and splurge and spend it.

If you want to put it to work, you have a set of priorities on what you might consider first, second, third, and fourth. What's priority number one? Where should you put that money to work first?

Benz: Well, I think you want to think like a business owner, a business operator, and think about what is the best bang for my buck given how much I have to invest.

So, certainly for folks with high-interest credit card debts, where you're not getting any tax benefit in having that debt, the interest rate is high, you'd want to put any proceeds from your tax refund toward that, because that is going to give you the highest-return payoff on your money. So that would be step one.

Stipp: So, say, I've got my debts under control, what's step two? What would I do if I have some of that refund money left over?

Benz: The other key thing I would focus on is making sure that you have an emergency fund that is appropriately funded. We usually think of that as being three to six months worth of living expenses, and it doesn't have to be three to six months of what you're spending now, but three to six months of what you could get by with in a pinch. And the high-return payoff of that is that if you did have to tap your credit card or some other source of funding [in an emergency], you could end up costing yourself a lot of money. So, you are better to create that emergency fund, make sure that you have money stashed away in true cash to pay for any emergency car repairs or home repairs or unanticipated expenses of any kind--a job loss, certainly.

Stipp: So, I've got my debts taken care of. I got my emergency fund build. Now I want to put some of that refund to work in the market. What kind of account should I consider first?

Benz: I think you want to focus on those accounts that do bring you some tax benefits by investing there. So, it really depends on what your priorities are in terms of your goals, but two key account types I would consider would be either a Roth IRA for people who are investing for retirement, or perhaps a 529 plan if you're investing on behalf of a child or a grandchild.

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