This year, the Internal Revenue Service is making it easier for Americans to resist the temptation to spend their refunds. They're creating a new program that allows taxpayers who use direct deposit to split their refunds in three specific accounts.
The idea is that more taxpayers will opt to put the money in their savings account or a retirement account, resulting in more Americans actually saving that once-a-year refund. Each year, more than three-quarters of U.S. taxpayers receive a refund, according to the IRS. In 2005, the average refund was $2,171, the IRS reported.
Taxpayers who expect to get a refund this year should consult with their financial consultant about how to best put that money to work and about the possible benefits of splitting up the refund.
Here are options to evaluate:
Save, save, save. The U.S. Commerce Department's Bureau of Economic Analysis recently announced that Americans had a negative saving rate in 2005, meaning that citizens spent more than they made. The personal savings rate is at the lowest since the Great Depression, the bureau reports. With that statistic in mind, it might be a good idea to plunk a good chunk of your refund into a savings account.
Most financial experts suggest saving enough to pay for three to six months worth of expenses. If something unexpected happens, like downsizing at your company, you have a cushion while you look for a new job. In addition, the money can help you pay for unexpected emergencies. It's nice to be able to dip into savings when your car decides it's driven its last mile or when your oven decides it has baked its last cake.
Some financial services companies have tools in place to support you as you save. Online goal-setting programs help you set goals - such as a vacation, home improvement or vehicle purchase - and a target savings amount. Consumers can set target timeframes for the goals, monitor their growth and schedule automated transfers from their primary accounts to their savings accounts.
Remember, though: Once you make your big purchase or dip into your emergency fund, be sure to set a new goal and build your savings back up!
Pay down debt. If you have a lot of credit card debt with high interest rates, it might be smarter to use the funds for reducing your credit debt. By doing that, you'll save yourself money in the long run. To decide the smart way to go, compare the interest rate on your credit card with the rate of return you might get by saving or investing the money.
Plan for retirement. Talk with a financial consultant about whether you should be using your tax refund for a long-term goal, such as retirement or an investment. A consultant can look at your overall financial picture and guide you as you decide how to best use your refund. For example, putting your tax refund in a retirement account could result in tax benefits that you might want to investigate.
Splitting the refund into multiple accounts will require taxpayers to use a Form 8888, and some details of the new program are still being decided, so be sure to check with a financial consultant or your accountant about how to use the new option. You can send the refund to any U.S. financial institution as long as you provide valid routing and account numbers.
If anything, dividing your refund money between these types of accounts might discourage the temptation to spend it all at the shopping mall. It's a great opportunity to set up a savings bucket so that you're accumulating your rainy-day fund and preparing for life's unexpected twists and turns.