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Cascade: No. 61, Spring 2006

Refund Splitting Opens the Door to Asset Building

Tax-preparation time provides a golden opportunity to foster asset building for low- and moderate-income (LMI) tax filers but only if various impediments can be overcome. One such impediment is the fact that many such filers do not have savings accounts.

D2D, a nonprofit begun in 2001, believes that sustainable access to financial products and services will only be achieved for LMI families by dramatically lowering the cost of serving them, primarily through the use of technology. Part of D2D’s approach is to strategically test technology to influence large institutions to create scalable solutions.1 D2D has created and tested Online IDA 2 and Refunds to Assets (R2A) as scalable asset-building systems. D2D, which was started with the guidance of Peter Tufano, a professor and senior associate dean at the Harvard Business School, has two full-time staff members and is funded by foundations and contracts.

During the 2006 tax season, D2D Fund, H&R Block, and seven community-based free tax-preparation sites are exploring an approach to overcoming these hurdles in partnership with local banks. This approach, involving direct deposit of tax refunds, has special significance in light of an announcement by the Internal Revenue Service (IRS) that starting in 2007 people who file their tax returns electronically can instruct the IRS to send their refunds by direct deposit to multiple accounts, a process called refund splitting. Also of potential importance is President Bush’s 2007 budget proposal for the creation of 900,000 individual development accounts (IDAs) for low-income people. The accounts would be supported by a tax-credit structure.

For most LMI households, a tax refund received in the form of an earned income tax credit (EITC), excess withholding, or child tax credit is the largest lump sum of cash received during the year. For instance, the average EITC refund is $1,700, and some refunds can be as high as $4,000. In 2004, the EITC program distributed more than $30 billion to over 20 million LMI households.

An individual is more likely to make a decision to save when faced with an unusually large lump sum of money.3 It is much more difficult to save money from weekly wages. Furthermore, during the tax-preparation process, the client does not yet have the money in hand. There is less temptation to spend. Indeed, much of the saving in the U.S. works this way: Social Security and 401(k) contributions are taken out of wages before the worker receives those funds. If a household with limited income is going to make a decision to save, perhaps the most sensible and productive time to do so is at tax time.

For years, asset-building advocates have recommended that the IRS institute a procedural change to allow direct deposit into more than one account – to allow refund splitting. The IRS’s decision to do so is a big step forward because it will be easier for every LMI tax-refund recipient to save at tax time. In effect, a pipeline has been built between the largest pot of potential savings for these families and accounts or products established for this purpose.

Simply making refund splitting available will not automatically achieve the potential of asset building. In two years of testing, D2D has identified hurdles that interfere with saving by tax clients. In particular, D2D focused its attention on barriers experienced at free tax-preparation sites.

There are over 4,000 such community-based sites, which are projected to prepare over 500,000 returns in 2006. These sites are primarily staffed by volunteers with limited resources who provide their services free of charge. The number of returns processed at the sites has increased at a double-digit annual percentage since 2002.

LMI tax filers need a simple, low-cost tool that is easy to understand and that facilitates refund splitting. In addition, they must overcome the hurdle of inadequate banking service at many sites. Many clients have no savings account. Some sites are fortunate to have a bank partner operating on-site – but this approach is not necessarily cost-effective on a large scale. Many clients encounter problems with ChexSystems and cannot open an account. Many struggle to begin building assets because they are participating in a cash-based economy.

To create a system to overcome these hurdles, D2D approached one of the largest providers of financial services to LMI households: H&R Block. D2D developed a manual system to track tax refunds and disbursements and, based on this experience, H&R Block created a software product that can accomplish this on a large scale. D2D worked with H&R Block to extend this large-scale capability beyond its offices.

H&R Block built an Internet-based software program, the Refunds to Assets (R2A) product, for use by volunteer income tax assistance (VITA) sites. R2A resides on computers of tax preparers at participating VITA sites and guides the preparers through the process of asking clients whether they want to split their refund. It then allows clients the option of allocating funds to existing checking or savings accounts. If the client does not have an existing account, he or she may open one on-site if a local banking partner is present or open a new low-cost transaction account (the H&R Block Debit Card) and/or an FDIC-insured interest-bearing savings account (Express Savings) provided through Irwin Union Bank, based in Columbus, Indiana. The accounts can be opened online and do not require ChexSystems’ review.

D2D is testing R2A at seven tax-preparation sites, in Chicago, Denver, Des Moines, New York City, Seattle, San Antonio, and Tulsa. The sites are also using a Spend Some, Save Some marketing campaign developed by D2D. The goal is to learn as much as possible about tax-client preferences as well as tax-preparer receptivity to promoting saving and using the refund-splitting process.

Refund splitting represents one more step in helping LMI households save for their future, but much work remains to be done. Perhaps tax clients will regularly save a portion of their refund in a special account. IDA participants might use splitting to make contributions and claim more savings match. Splitting might also be used to pay down debt or to fund IRAs, U.S. savings bonds, college savings accounts, or other asset-building vehicles. While not a cure-all, refund splitting can be the basis of a strategy linking tax time to an annual ritual of saving and asset building.

Before helping launch D2D Fund, Jeff Zinsmeyer served as director of community development and low/moderate income marketing for FleetBoston Financial’s Community Investment Group. Prior to Fleet’s purchase of BankBoston, he helped develop BankBoston’s First Community Bank. For information, contact Zinsmeyer at jzinsmeyer@d2dfund.org; www.d2dfund.org.

  • 1 In 2004, D2D and the Community Action Project of Tulsa County tested a refund-splitting system that gave EITC-eligible and other low-income taxpayers the choice to split their refund into saving and spending portions at the time of return filing. Over 500 tax filers were offered the opportunity to split their refunds between a savings account and a refund check. The average income of these tax filers was $12,300. Of the people who were offered the opportunity, about one-fourth wanted to participate. A major reason that filers did not participate was their inability to open savings accounts due to ChexSystems disqualification. Seventy-nine clients saved, and on average, those who used the service deposited $606, or 47 percent, of their refunds into savings accounts. Seventy-five percent of these individuals had no prior savings.
  • 2 Online IDA is a web-based, integrated financial transaction and record-keeping system built in partnership with SunGard Data Systems. By replacing an IDA delivery model built on parallel systems – one for financial institutions and a second for IDA program sponsors – Online IDA eliminates time-consuming monthly data transfers between banks and IDA programs. Online IDA operates on a system architecture capable of serving hundreds of thousands of households. It has been tested in two versions, with about 120 LMI IDA participants saving online.
  • 3 Hersh M. Shefrin and Richard H. Thaler. “Mental Accounting, Saving, and Self-Control,” in G. Loewenstein and J. Elster, eds., Choice Over Time (New York: Sage Foundation), 1992; Richard H. Thaler, “Psychology and Savings Policies,” American Economic Review 84 (May 1994), pp. 186–92.