Using Tax Refunds to Increase Savings and Retirement Security

QUICK SUMMARY

Allowing households to split their refunds could make saving simpler and, thus, more likely. Since federal income tax refunds total nearly $230 billion a year (more than twice the estimated annual aggregate amount of net personal saving in the United States), even a modest increase in the proportion of refunds saved every year could bring about a significant increase in savings.

This policy brief explores the important potential of refund splitting to expand savings and discusses the obstacles and practical steps needed to make the splitting of tax refunds a reality.

Most American households receive an income tax refund every year. Instead of receiving the refund in the form of a check, a taxpayer may instruct the Internal Revenue Service to deposit the refund in a designated account at a financial institution. However, the direct deposit can be made to only one account. This all-or-nothing approach discourages many households from saving any of the refund. When some of the refund is needed for immediate expenses (as is often the case), depositing the entire amount in a saving account, such as an individual retirement account (IRA), is not a feasible option. Yet the IRS does not currently permit the direct deposit of only part of the refund in such an account.

Allowing households to split their refunds could make saving simpler and, thus, more likely. Since federal income tax refunds total nearly $230 billion a year (more than twice the estimated annual aggregate amount of net personal saving in the United States), even a modest increase in the proportion of refunds saved every year could bring about a significant increase in savings. The administration has supported divisible refunds in each of its last two budget documents. Yet the necessary administrative changes have not yet been implemented.

The first section of this policy brief explores the important potential of refund splitting to expand savings. The second section discusses the obstacles and the practical steps needed to make the splitting of tax refunds a reality.