Save or Spend: What Will You Do With Your Tax Refund?

April is not the cruelest month -- at least, not when it comes to getting a little extra cash in your pocket.

For more than three-quarters of American taxpayers, the silver lining of tax season is getting a refund check. This year, the average refund is just under $3,000, according to the Internal Revenue Service. For many, the top priority for that money will be paying off debt or covering other expenses. But for others, it's an opportunity to save or make an investment.

Tricia R. Schroeter, who works as research administrator in Palo Alto, Calif., says she and her husband used their 2010 refund of about $5,000 to pay a chunk of their property taxes. They own a home in San Mateo County, where their annual property taxes add up to more than $10,000.

"We pay about half in December," she says. "Then we hope we get a refund to pay toward it in April." Schroeter says she has always taken a pragmatic approach to her IRS refunds. Fifteen years ago, she was a single mom and had to make every penny count.

"I made sure I would claim enough so I would get a return," she recalls. "It always went to paying bills. I could never afford to buy luxury."

Like Schroeter, millions of Americans rely on the annual refund to save money throughout the year as a way to pay bills or other expenses. Nearly 50% of taxpayers surveyed in February 2011 by the National Endowment for Financial Education planned to pay down debt with their expected refund; 44% said the money was earmarked for savings.

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Get the Most Bang for Your Buck

If you owe debts in multiple places, following the playbook for good financial planning may not be as simple as pay down or save.

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Carmen Wong Ulrich, author of the The Real Cost of Living, says you need to ask yourself where you will get the most bang for your buck. High-interest-rate credit cards should be the first priority when paying down debt.

For savers, she advises padding your bank account to have a "pop-up expense fund."

"Sometimes as little as an extra couple hundred dollars in your account can be the difference between going into debt when the car breaks down or the heater conks out, and not going into debt," Ulrich says. "Fund that pop-up fund if you don't have one, and then your emergency fund."

Is Your Withholding Too High?

While a tax refund is a sweet financial booster -- helping to pay bills and further financial or career goals -- experts debate whether the prevalence of big refunds may actually hurt some taxpayers, particularly low-income groups.

Damon Jones, an assistant professor at the Harris School of Public Policy at University of Chicago, has researched why refunds are deployed. He argues that one reason they have become so prevalent is simply that people don't take the time to adjust their income withholdings throughout the year.

"For people who live paycheck-to-paycheck, they could lower their withholdings and that additional income on each paycheck could be useful in making ends meet," he says. "Instead, that money is backloaded into a refund and affects the timing of income during the year."

As a financial planning expert, Ulrich agrees. She advises people to look closely at how much income they are withholding. Overpaying is, in the simplest terms, giving the government an interest-free loan on your money.

"A refund means that you've been handing your money over to the IRS with every single paycheck -- too much money. And that money that should be in your pocket or your bank account," she says. "Work on your withholding numbers so you don't get a big check next year but instead get a bigger paycheck every month."

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Investing in Yourself

If you do have the urge the splurge, you're not alone. Tony Tavarez, 28, works as a public safety officer and actor in New York City. He has the luxury of saving and spending his refund this year.

In 2010, Tavarez (pictured, right) went to school and had many medical expenses that counted as write-offs. That earned him an unexpectedly large refund of about $5,000 this year. Originally, he planned to open an IRA account with his refund, but after an acting gig this winter revived his commitment to his creative career, he opted to spend $1,700 of his refund on a membership with AFTRA, the union for television and radio artists.

"I thought it would be good investment in my career and motivate me to take what I want to do more seriously," Tavarez says. The remainder is going into savings to pay for classes this summer at the Atlantic Theater School.

Investing in self-growth is another way to spend a check from the IRS. Take Allison (not her real name), a lively 30-something office manager who lives in New York City. She used her tax refund to buy sessions with a dating coach. Since breaking up with a serious boyfriend several years ago, none of her relationships has lasted more than a few months. This is her year to change that trend, she says.

"I've worked on my health with an acupuncturist, and I have worked on my body with private yoga and pilates with great results. Since it's not a sacrifice to do this with my tax return money, working with a dating coach makes sense to me," she says. "I don't want to be single the rest of my life."

Purchases that can add real value to your family's quality of life are important as well. "Think of these as 'investments' in your life as they lead to happiness, shared memories and peace of mind," says Ulrich. She suggests spending on things that can bring your family together, like a vacation or new bikes for the summer.

For other taxpayers, a little extra cash is just that: mad money for a special indulgence.

"I am getting an iPad," says Charlotte Thomas-Davison, 35, an architect who lives Providence, R.I. Her refund this year was around $900. The remainder she says is going to treats for her dog, a 13-year-old rescue greyhound.

"He worked hard this year," she says about her pooch Wyatt, who likes to sleep on the couch. "He deserves a treat too."


Catherine New is a personal and consumer finance reporter for DailyFinance.com and Aol Huffington Post.