A Tax Refund is a Great Way to Jump-Start Savings Rates

As we move into tax-preparation season, here's a thought for what to do if you get a tax refund--give your savings an instant boost by having that refund deposited directly into a savings or money market account.

The Internal Revenue Service (IRS) allows you to specify up to three accounts on your tax return where your refund is to be deposited. Consider this a sensible alternative this year to receiving a refund check. With personal savings rates too low for many Americans and cash reserves depleted by the recession, the option of depositing a refund check directly into savings could not come at a better time.

Consider the Alternatives

If you are due a refund from the IRS, you have options aside from having the refund directly deposited into a savings account. However, going through all the options makes it clear that the direct deposit into a savings account is the most productive one:

• You could apply the refund against next year's tax liability. This means letting the government use your money interest-free for a year, when you could be earning interest on that money yourself. Also, unless your tax situation is highly variable, if you overpaid this year and had a refund coming, what's to say next year won't be the same? You may end up advancing the government your money indefinitely.
• You could receive a check for your refund. This is the traditional route, but it means missing out on interest until you can get that check deposited. Of course, you just have to look at all the tax refund sales that retailers have to know a great deal of that money never makes it as far as the bank. Getting a refund check, if you're not the disciplined type, can almost be like earning negative interest--not only aren't you depositing the money right away, but you could be induced to spend it all on stuff you don't need rather than save it.
• You could try the direct deposit option. This will start you earning interest at the earliest possible date the IRS processes your refund. As importantly, if the money never passes through your hands, you'll be less tempted to spend it. Direct deposit can represent a painless boost to savings rates.

Making the Most of Bank Rates

Of course, low bank rates may seem like they offer little inducement to do the right thing and save your tax refund for retirement or a rainy day. However, the fact that savings account interest rates are low means it is all the more important to deposit more into savings accounts--it doesn't make sense to shortchange your retirement goals by saving less just because interest rates are low right now. This means getting money into an interest-bearing account as quickly as possible and putting as much money as you can afford into such an account. Direct deposit of your tax refund can accomplish both of these goals.

You can also get more out of bank rates if you shop around on Money-Rates.com before you designate a deposit account on your tax return. Savings account rates and bank rates in general may be low, but they are surprisingly variable across institutions. Shopping for the best rates around can make a significant difference.

As part of your tax preparation process this year, spend some time on Money-Rates.com and find a competitive savings account rate. Then, open an account and designate that account for direct deposit of your tax refund. You may not miss a refund check this spring, and you may be very glad for the extra boost when retirement rolls around.