leveraging tax refunds to encourage saving

The Ret i rement Secur i ty Pro ject

The RetirementSecurity Project

LeveragingTax Refundsto EncourageSaving

Nº 2005-8

The Retirement Security Project

is supported by

The Pew Charitable Trusts

in partnership with

Georgetown University's

Public Policy Institute and

the Brookings Institution.

Advisory Board

Bruce BartlettSenior Fellow, National Center forPolicy Analysis

Michael GraetzJustus S. Hotchkiss Professor of Law,Yale Law School

Daniel HalperinStanley S. Surrey Professor of Law,Harvard Law School

Nancy KilleferDirector, McKinsey & Co.

Robert RubinDirector, Chairman of the ExecutiveCommittee and Member of the Officeof the Chairman, Citigroup Inc.

John ShovenCharles R. Schwab Professor ofEconomics and Director, StanfordInstitute for Economic Policy Research,Stanford University

C. Eugene SteuerleSenior Fellow, The Urban Institute

Commonsensereforms,real worldresults

www.ret i rementsecur i t yprojec t .org

The Retirement Security Project • Leveraging Tax Refunds to Encourage Saving

1august 2005

Introduction

Policy-makers from both sides of thepolitical aisle are actively seeking ways toencourage retirement saving amongmiddle- and low-income households.A growing body of evidence suggests thatmaking it easy for these families to save,and presenting them with clear andeffective financial incentives to do so,succeeds in generating significantly highercontributions to retirement accounts.

One of the most auspicious ways to makeit easier for households to save, forretirement and other purposes, is byallowing them to directly deposit part oftheir income tax refund into a savingsvehicle. This policy brief examines waysof encouraging households to save at oneof their most “savable” moments: whenthey learn they will receive a substantialfederal tax refund.

Currently, the Internal Revenue Service(IRS) permits refund recipients to identify asingle destination for refunds. Many havecalled for the IRS to allow refundrecipients to split their refunds, to facilitatesaving in the same way that most payrollsystems let employees “split” theirpaychecks and deposit part in savingsproducts. The splitting proposal has beenadopted by the Bush Administration andhas been in the budget for the last twoyears. Twelve Members of Congresswrote to IRS Commissioner Mark W.Everson on January 31, 2005, requestingthat the IRS adopt technical changes thatwould enable split refunds. On March25, 2005, Commissioner Everson repliedthat the IRS was “working toward makingthis program available as quickly aspossible” and set a deadline of the 2007filing season. This policy brief addressessome practical issues with this idea,which are also partially addressed in anupcoming Retirement Security Projectpolicy brief by Mark Iwry.1 In particular,we advance the idea of establishing a

refund-based savings option available toall at tax time—U.S. savings bonds,purchased out of a filer’s refund.

The policy brief describes results from anexperiment we conducted thatunderscores the potential benefits fromthis split refund proposal. The experimentwas not focused specifically on retirementsavings, but nonetheless provides insightinto the process of saving for otherpurposes—as well as the steps thatwould be necessary to encouragehouseholds to set aside part of theirincome tax refund specifically forretirement purposes. The core of theexperiment involved offering refundrecipients the ability to “split” or “bifurcate”their refunds, i.e., to direct refunds tomultiple destinations. One of thesedestinations was a simple bank savingsvehicle.

The results were quite promising in someways. A meaningful fraction (about 20percent) of all refund recipients sought tosave part of their refunds using ourprogram. Nearly three-quarters of thesewere “greenfield” savers, who reported noprior savings. Participants reported highlevels of satisfaction and appeared tohave spent their money on theirpredetermined goals.

At the same time, however, the vastmajority of those making contributionsappear to have withdrawn the fundsrelatively quickly. Although thesewithdrawals may have fulfilled variousgoals that households had earlieridentified, they nonetheless mean thatlittle of the deposited funds were retainedas long-term savings. To the extent suchretention is a goal for policy-makers,other steps may be required to makethese assets more “sticky,” possiblyincluding framing them as retirementsavings.

Leveraging Tax Refunds to Encourage SavingBy Peter Tufano, Daniel Schneider, and Sondra Beverly

One of the most

auspicious ways to

make it easier for

households to save,

for retirement and

other purposes, is

by allowing them to

directly deposit part

of their income tax

refund into a

savings vehicle.

Background

One promising way to encourage savingand asset building in low-incomehouseholds is to leverage federal incometax refunds. The rationale is twofold.First, many low- and moderate-income(LMI) families receive large tax refunds.2

In 2001, LMI tax filers received more than$78 billion in total federal refundpayments, including the Earned IncomeTax Credit (EITC), the Child Tax Credit,other refundable credits, and refundsfrom overwithholding.3 This massive flowof funds, which takes place primarilyduring a few weeks in the early part ofthe tax season, represents a substantialportion of the inflows of an LMI family.With an average value of $1,546 in 2001,refund payments are often hundreds ofdollars more than a low-income family’sregular biweekly paycheck.4

In addition to being large, federal taxrefunds are perhaps the most savable ofincome flows. Tax refunds differ fromemployment earnings and public benefitsprimarily because they arrive (at most)once a year. Irregular income flows—especially large ones—may be mentallydefined as “assets” rather than “income.”5

In fact, research suggests that low-income families anticipate tax refunds andplan to use refunds differently thanemployment earnings. Although manyfamilies use at least part of their refundsto catch up on purchases and overduebills, a sizable proportion also savessome and/or uses a portion to purchasefurniture, cars, and even homes.6

The delay between tax filing—when anindividual learns how much refund she willlikely receive—and refund receipt maygenerate another reason that refunds aresavable. This delay, which is sometimesshort but often amounts to a week or

two, allows an individual to precommither refund to saving before the money isin hand.7 The ability to precommit is veryvaluable if people undersave, in partbecause they are unable to resistspending temptations once they have themoney in hand, as behavioral economistssuggest.8 As a result, programs thatpromote saving out of tax refunds havereal potential. As early as 1994, RichardThaler recognized the savings opportunitypresented by tax refunds and argued foran additional credit for filers directlydepositing refunds into IndividualRetirement Accounts (IRAs).9

In the following sections, we recommendthree ways to leverage tax refunds forsaving and asset building: (1) allow refundrecipients to create new accounts withtheir tax refunds; (2) allow refundrecipients to create new accounts andsplit their refunds; and (3) allow refundrecipients to purchase U.S. savings bondswith refunds. We focus primarily on thesecond of these recommendations anddescribe new data from our experimenton the effects of refund splitting.

Leveraging Tax Refunds:Program and Policy Options

Encourage Account Opening

Evidence that low-income familiessometimes view refunds as a source ofsavings has led both for-profit and not-for-profit organizations to offer accountsat the time of tax preparation. Theseprograms usually involve a partnershipbetween a tax preparer (commercial orvolunteer) and a financial institution. Oneof the earliest of these experiments was apartnership between the Center forEconomic Progress (CEP) andShorebank.10 In 2000, about 450 LMIChicago residents who used CEP’s


2 august 2005


3august 2005

Follow-up surveys

and interviews with

participants who

were unbanked at

the time of

enrollment suggest

that opening an

account may have

served as a first

step toward savings

and toward a

greater connection

with mainstream

financial products.

volunteer tax-preparation service wereinvited to open low-cost Shorebanksavings accounts on site. About one-fifthof the tax filers enrolled, arranging tohave their refunds directly deposited intothe new accounts. This take-up rate,and the comments provided inparticipant surveys and interviews,reveals: (1) a desire to save and (2)demand for low-cost accounts. Mostparticipants depleted their accounts fairlyrapidly, but 14 percent maintainedbalances and perhaps added savings.Follow-up surveys and interviews withparticipants who were unbanked at thetime of enrollment suggest that openingan account may have served as a firststep toward savings and toward agreater connection with mainstreamfinancial products.11

More recently, commercial tax preparershave encouraged individuals to openaccounts with refunds. For example, in asmall pilot program, some H&R Blockoffices have encouraged clients to opensavings accounts on site with therequirement that they directly deposittheir entire refund into the account. Theaccounts were marketed as a way toaccumulate emergency savings.12 In the2003 tax season, Block openedapproximately 400 such accounts, withan average opening balance of $870.Only 2 percent of clients at the officesthat offered the service opened accounts,but take-up was depressed by rigorousaccount-opening requirements based ona credit check.13 H&R Block has alsoencouraged refund recipients to openIRAs on site. Over the four tax seasonsfrom 2001 to 2004, the company openedapproximately 420,000 “Express IRA”accounts. In 2004, the average balanceon the 284,000 accounts still open was$693.14

In a new study, a team of researchersassociated with The Retirement SecurityProject has been working with H&RBlock to test whether augmentingrefunds to provide incentives for IRAopening is effective. The preliminaryresults show that IRA contributions

increase with the level of match fundingoffered.15

Encourage Account Opening andRefund Splitting

If people undersave because they havetrouble resisting spending temptations,and if mental accounting helps peopleset aside money for savings, then refundsplitting—physically separating fundsdesignated for saving from fundsdesignated for spending—may be avaluable tool to encourage saving.Currently, the IRS will send a refund toonly one account, and most low-incomefamilies cannot save all of the refunds.Thus, whether the money is sent viapaper check or directly deposited in asingle account, the would-be saver mustreceive the entire refund, make a decisionabout saving, and then execute thesavings plan while spending part of themoney. This leaves them open tospending temptations.

Refund splitting, by contrast, allows therecipient to mentally and physicallyseparate saving and spending moneyand make saving automatic, therebyreducing the mental energy required tosave. The intention to save is furtherreinforced if the savings portion isdirected to a savings-oriented financialproduct. This intention can bestrengthened even more if the productimposes some restrictions onwithdrawals.16

Some higher-income families haveaccess to refund splitting. Vanguard, thesecond largest mutual fund company inthe United States, allows investors tosplit their refunds between as many asfour existing Vanguard accounts(including money market accounts withcheck-writing privileges that can be usedas transaction accounts). Prior to taxfiling, a would-be splitter files a form withVanguard outlining the allocation of therefunds. The filer then submits a generalVanguard account number and routingnumber on her tax return, and Vanguardautomatically splits the refund deposited


4 august 2005

into this account according to thepreviously issued instructions.17 In 2004,Vanguard was the only company out ofthe 10 largest banks and 10 largestmutual funds with a formal splittingservice,18 but some customers withbrokerage accounts in other firms may beable to have their brokers automaticallysplit refunds across multiple investments.Unfortunately, LMI families are not likelycustomers of Vanguard (whose fundstypically require a minimum investment of$3,000) or of brokerage firms.

LMI families do have access to somerefund splitting, albeit of a different form.Clients who take out refund anticipationloans (RALs) split their refunds, sendingsome to pay the tax preparer andreceiving the remainder. RAL splittingdoes not build assets, however, butinstead satisfies the need for immediatespending. Clients opting to purchaseH&R Block’s Express IRA product at thetime of tax preparation have the option ofsplitting their refunds, directing some tothe newly opened IRA and receiving someas a direct deposit or as a paper check.19

The Experiment and Results

During the 2003 tax season, a refund-splitting program targeted to LMIhouseholds was piloted in Tulsa,Oklahoma.20 This program, called Refundto Assets (R2A), was a partnership of theCommunity Action Program of TulsaCounty (CAPTC), D2D Fund (D2D), andthe Bank of Oklahoma (BOk).21 Clients attwo of CAPTC’s free tax-preparation siteswere invited to split their refunds, sendingpart to a savings account via directdeposit and arranging to receive the restby mail as a check. Participants werealso able to open new savings accountsthrough BOk without leaving the tax-preparation site. To be eligible, clientshad to be at least 18 years old, have anexpected federal tax refund, and agree toa set of legal authorizations. In addition,clients wishing to open a BOk accounthad to pass an industry-standard creditscreen (ChexSystems) and have a validdriver’s license or passport.

The pilot program was offered in twoperiods during the tax season—during thefirst two weeks of February (the peakseason for filing by those expectingrefunds) and for two weeks in March.Recruitment and enrollment occurred onsite while individuals were waiting to meetwith tax preparers. CAPTC staff and/or amember of the research team used aprepared script to describe R2A,emphasizing the program as a tool to splitrefunds and to encourage saving.Although the script encouraged refundsplitting, individuals who wanted to opennew BOk accounts and deposit theirentire refunds into these accounts wereallowed to do so. Typically, the savingsportion was directly deposited about 10to 14 days after the date of tax filing, andthe participant received the remainder asa check shortly thereafter.

In brief, about 27 percent of 516 refundrecipients sought to participate in the R2Aprogram (takers). Fifteen percent wereable to participate (participants), with theremainder being foiled because they didnot meet various eligibility standards, asdescribed above. Each participant hadthree choices: she could split her refundand open an account, split into anexisting account, or simply open anaccount. Among those who successfullyenrolled, 56 percent used both services,27 percent only split, and 17 percent onlyopened an account. For the remainder ofthis brief, we report on all R2Aparticipants, regardless of serviceschosen, but the breakdown by servicetype is described in our more detailedpaper on this topic.22

Table 1 presents various financial anddemographic characteristics ofparticipants. The 79 participants had anaverage age of 35, were predominantlyfemale, and were predominantly African-American or Caucasian. Their federal taxrefunds averaged $1,381. Over half ofthe participants held full-time jobs, andmore than three-quarters worked at leastpart time. However, 12 percent ofrespondents were unemployed andcurrently looking for work, a figure that

5august 2005

was twice the national unemployment rate. The averageadjusted gross income (AGI) was $12,297. Overall,participants might be described as the “working poor.”23

At the time of enrollment, participants were asked whatthey planned to do with their refunds. Eighty-onepercent of participants said they planned to save part oftheir refunds. The most common savings goal, namedby 16 percent of participants, was “general” savings,including responses such as “to build savings” or “justto have money.” The next most common savings goalswere saving for housing-related uses, saving foremergencies, and vehicle-related savings. Retirementsavings was mentioned by only 5 percent ofparticipants, although that was slightly higher than thosewho stated that they wanted to save for their children.The results for respondents’ planned savings goals arepresented in Table 2.

R2A participants initially contributed substantialamounts to savings accounts. The mean participantdirected $606 into savings, which represented 47percent of the refunds for the mean participant, or 9.8percent of the total refunds for all participants. Themedian participant directed $203 into savings, andthese deposits represented 39 percent of refunds.

Individuals who reported having some savings whenthey enrolled in the program had larger refunds anddirected a larger percentage of their refunds to savings


Table 1: Demographic Characteristics of R2A Participants

Income Federal Refund Age

Mean $12,297 Mean $1,381 Mean 35Standard Deviation $9,264 Standard Deviation $1,446 Standard Deviation 13Median $10,526 Median $648 Median 32

Misc. Gender Marital Status

Has Health Insurance 45% Female 57% Single, Never Married 53%Owns Home 31% Male 43% Separated or Divorced 27%Children in Household 52% Married 16%Receives Public Assistance 27% Widowed 4%

Employment Race/Ethnicity Education

Working Full-Time 60% African-American 50% Less than HS Diploma 14%Working Part-Time 16% Caucasian 39% HS Diploma or GED 37%Not Working, Looking for Work 12% Native American 3% Some College 33%Not Working, Student 8% Hispanic 5% Associate’s Degree 8%Not Working, Other 4% Other 3% Bachelor’s Degree 8%

Source: Beverly, Schneider and Tufano (2005)

Table 2:Percentage of R2A Participants

Articulating Specific Savings Goals

Any savings goal 81%General savings 16%Emergency savings 13%

Home improvement, purchase, or rental 15%Car purchase, repair, or other 13%Education 4%Business 1%

Retirement 5%

Children 4%Gifts, weddings, funerals 4%Bills 3%Medical 1%Durables 1%Move 1%Living expenses 1%Miscellaneous 7%

Note: This table contains data from self-administered baselinesurveys of program participants. The question asked participants ifthey planned to save some of their refunds, use some for debtrepayment, or spend some. Several spaces were provided undereach option for the respondent to detail the specific use. Theseopen-ended responses were then grouped and coded by theauthors. Only the savings responses are presented here.Source: Beverly, Schneider and Tufano (2005)

accounts. In contrast, greenfield savers—individuals without savings at baseline—received smaller refunds and directed asmaller percentage to savings. Withsmaller refunds and smaller sharesdirected to savings, greenfield savers sentan average of $479 to savings versus$924 by existing savers.

In a follow-up survey administered threeto five months after tax filing, R2Aparticipants were asked how they hadused their refunds and how much theywere still saving. Of those who reportedat baseline that they planned to savesome of their refunds, 72 percent saidthey were still doing so. Among the 23participants who planned to save andreported still saving, mean savings was34 percent of refunds, median was 23percent. Seventy-eight percent were stillsaving some portion of their refunds orhad spent on a stated savings goal.24

These outcomes for R2A participantswere examined against outcomes for acomparison group. The comparisongroup included filers at another CAPTCtax-preparation site who did not haveaccess to the R2A program but said theywould be interested in a program likeR2A. Participants were more likely thancomparison group members to say theywere still saving a portion of their refunds.However, differences in amount saved(measured in dollars and as a percentageof refund amounts) were not significantlydifferent. These findings should beinterpreted with caution because therewere some important demographicdifferences between these two groups.25

We also compared participants’ reportedsavings at follow-up with their self-reportsabout saving out of their 2003 taxrefunds. The comparison reveals thatparticipants believed that they savedmore of their refunds in 2004, when R2Awas used, than in 2003, when refundsplitting was not available.

In addition to self-reported data on savingand spending out of refunds, the Bank ofOklahoma provided limited data for 58 ofthe 66 individuals who opened an

account with BOk or split to an existingBOk account. Of these participants, 38percent had closed their accounts bymid-August 2004, while 62 percent stillhad active BOk accounts at least throughthe end of November 2004.

Data on end-of-month account balancesshow that participants rapidly withdrewmoney from their accounts. This sub-sample of 36 participants initially depositedan average of $644 into their BOkaccounts. The average balance droppedto $112 by August (26 weeks after mostparticipants received their refund) and to$27 by November (38 weeks after refundreceipt for most participants).

The rapid depletion of the accounts mayreflect several factors. First, and most likely,the withdrawals may have fulfilled othergoals of the participants, even if those goalsdid not involve long-term savings. Manyparticipants articulated a variety of concreteshort-term and medium-term savings goals,as listed in Table 2; it is very plausible thatthe funds went to meet these needs.Second, the lack of withdrawal restrictionson the accounts may have encouragedmore withdrawals than would occur in otheraccount structures, including IRAs, althoughmore restricted withdrawal rules may alsohave discouraged contributions in the firstplace. Finally, it is possible that thehouseholds depleted their accounts toavoid disqualifying themselves from variousmeans-tested benefit programs (likeMedicaid and food stamps) with assettests.26

Attitudinal questions in a follow-up survey,as presented in Table 3, suggest that R2Afacilitated saving and thoughtful spending.Eighty-three percent of respondents saidthe service helped them spend theirrefunds more slowly, and 76 percent saidthe service helped them resist spendingtemptations. In addition, all respondentssaid they would recommend R2A to afriend, and 97 percent planned to split theirrefunds again next year. On average,participants said they were willing to pay$6.60 to split their refunds, and 89 percentwere willing to split even if they had to waitlonger to receive their refunds. These


6 august 2005

Of those who

reported at baseline

that they planned to

save some of their

refunds, 72 percent

said they were still

doing so.

7august 2005The Retirement Security Project • Leveraging Tax Refunds to Encourage Saving

limited results suggest that participantsperceived material benefits from theservice, albeit not benefits related to long-term savings goals.

Addressing Impedimentsto Scale

While our small pilot suggests that there isdemand for a refund-based savingsprogram, there are impediments to takinga simple splitting program to scale. In theR2A pilot, only 27 percent of theparticipants split into an existing account,with the remainder opening accounts.Slicing the data another way shows thatthe demand for splitting alone (4 percent)was less than half the demand forsplitting coupled with account opening(8 percent).27 This suggests that the abilityto open new accounts was an attractive—and perhaps essential—feature of ourprogram.

Yet, if refund splitting is to be offered incombination with account opening, some

practical issues must be resolved. Thestandard operating procedure for thepartner bank in R2A—and we believe formost banks—is to deny accounts, evensavings accounts, to potential saverswho have prior negative bank records.We found that 42 percent of would-beR2A participants could not participate inthe program because low ChexSystemsscores made them ineligible for BOkaccounts. Thus, participation inprograms like R2A will be depressedunless the ChexSystems screen iswaived or softened.

Although BOk did not waive theChexSystems screen, the bank did forgothe $100 initial deposit requirement andthe $300 minimum balance requirementfor participants. This encouragedparticipation in R2A, but taking thisprogram to scale will not be possible ifprogram administrators must depend onthe goodwill of individual financialinstitutions to waive requirements ofthis sort.

Table 3:Responses to Follow-up Survey Attitudinal Questions for Participants

All Participants

Percent who “strongly agree” or “agree” that:Service helped to save more of refund 83%Service helped to spend refund more slowly 83%Service helped to resist spending temptations 76%

Percent who are “very likely” or “somewhat likely” to:Split next year 92%

Percent “very interested” or “interested” in:Still splitting even if had to wait longer for refund 89%

Would recommend service to a friend (Y/N) 100%

Average amount willing to pay to split refund $6.60

N 41

Note: This table contains survey data from follow-up telephone surveys of program participants.Participants were asked a series of questions designed to gauge their satisfaction with R2A andtheir feelings about the program’s effectiveness. Participants were also asked several questionsabout possible future use of a splitting service. Respondents who did not split were askedhypothetical questions about their interest in splitting.Source: Beverly, Schneider and Tufano (2005)

Thus, participation

in programs like

R2A will be

depressed unless

the ChexSystems

screen is waived or

softened.

Other account-opening issues relate tooperational flow. R2A changed the flow ofthe tax-preparation site because accountopening required an additional step withdifferent personnel. This would not workfor self-preparers or even for thinly staffedtax-preparation sites. As much as a thirdof all LMI returns are self-prepared, andwe suspect that a meaningful fraction ofthe volunteer tax-preparation sites (whichprocess 1 to 3 percent of LMI returns)might be operationally challenged by therequirements to open accounts on site.28

These practical problems might beavoided if people can split to a savingsproduct that is not housed in a bank. Inour experiment, splitting options werelimited to bank products for two reasons.These simple products are more easilyunderstood by savers, and opening someother products, like mutual funds,requires the in-person or telephonepresence of a registered broker-dealer.We suggest a different nonbank splittingoption, U.S. savings bonds.

In our view, splitting is a necessary, butnot sufficient, condition to making refund-based savings programs work. Manydifferent types of approaches to addressthe issues raised above are possible. Alarge preparer, like H&R Block, might beable and willing to change its processflow to facilitate account opening. D2DFund is working on other private-sectoractions that could lower the operationalcosts and efforts for other preparers.These innovations could include enablingfilers to complete the paperwork foraccount opening offline yet still complywith IRS direct-deposit requirements,giving refund recipients the ability to takepart of their refund in a card-basedproduct or using information technologyto speed up and centralize the account-opening process.

While the IRS may offer basic splittingfunctionality, it should also work with theprivate sector to establish or clarify rulesto facilitate private innovation in splitting.Our study suggests that there is demandfor a wide range of destinations forrefunds if split. In a follow-up survey, we

asked to what destinations filers mightlike to direct their split refunds; optionsranged from a host of savingsdestinations to a variety of transactionaccounts (e.g., checking, paper check,stored value cards, and internationalremittance) to debt repayment, the resultsare shown in Table 4. The IRS itselfwould probably wish to support splittingonly to a narrow range of destinations,such as online accounts with valid bankrouting and account numbers. The privatesector might be willing to meet a broaderset of consumer demands.

Getting refunds into some of thesedestinations might require clarification orchanging of IRS rules. For example, ournonlawyer’s reading of the tax codesuggests that the IRS contemplates onlysending funds to a separate account held


8 august 2005

Table 4:Interest in Refund-Splitting

Destinations, R2A Participantand Comparison Groups

Percent “somewhat” or “very” likelyto split into:

Savings

Savings Account 92%Retirement Savings 53%College Savings 51%Certificate of Deposit 29%US Savings Bond 24%Mutual Fund 21%

Transaction

Checking Account 88%Paper Check 65%Stored Value Card 40%International Remittance 22%

Debt

Car Loan 45%Credit Card 44%Mortgage 42%

N 60

Source: Beverly, Schneider and Tufano (2005)

These practical

problems might be

avoided if people

can split to a

savings product

that is not housed

in a bank.

by the filer.29 Yet, many of the mostrobust pools of savings are held inomnibus accounts, such as 401(k) or403(b) products, where recordkeepingsystems track individuals’ claims oncommon pools. The IRS could clarifyrules so that money could be directedtoward (or through) these pooled vehicles,as long as safeguards protect theinterests of the refund recipient. Anupcoming policy brief by Mark Iwrydiscusses other administrative issues thatthe IRS would need to address, includingdata errors, storage and processingconcerns, and coordination of a splitrefund program with IRA contributions.30

A “Universal” Savings Vehicle:Savings Bonds

More importantly, as a matter of policy, itwould be desirable to create a universal“savings vehicle of last resort” to ensurethat all willing savers have an opportunityto save. This tax-time savings vehicleshould offer market-based returns whileexposing the investor to relatively low risk,be available in small denominations, beportable as people move, and be simpleto explain and understand. Ideally, it willalso encourage, although not force,families to frame this decision in terms ofsavings rather than almost immediateconsumption. In a related paper, wepropose that one simple way to enableeveryone—regardless of accountownership—to save out of his or herrefund is to allow refund recipients toreceive part of their refunds in U.S.savings bonds rather than in cash.31

Savings bonds are an attractive solutionfor a number of reasons. Savings bondswere originally created to help low-income families to save and build wealth.First introduced as Liberty Bonds duringWorld War I, and then widely marketedand sold in the 1930s and 1940s, savingsbonds were “designed for the smallsaver—that he may be encouraged tosave for the future and receive a fairreturn on his money.” 32 The need forsavings bonds persists. Mainstreamfinancial institutions seem largelyuninterested in selling savings and

investment products to many low-incomeindividuals. Banks and credit unionstypically use ChexSystems scores,minimum initial-deposit requirements, andminimum balance rules to discouragesmall savers. Mutual funds often set highinitial-purchase requirements that make itdifficult for low-income savers to buymoney market, stock, or bond mutualfunds. On the positive side, savingsbonds meet all the attributes we describeabove of an acceptable savings vehicle oflast resort.

We propose that refund recipients be ableto instruct the IRS to use a portion oftheir refunds to purchase savingsbonds.33 By adding a single line to thetax form, it would be possible to ensurethat every American family had access toat least one savings option at the timethey filed their taxes.

Our experiment gives us reason to believethat there might be some meaningfuldemand for savings bonds. In follow-ups, we asked participants if they wouldbe interested in savings bonds as adestination for their funds, andapproximately a quarter were interested.When we explained the terms of thebonds, about three-quarters wereinterested. Ultimately, the demand forthis product will be known only throughoffering it and observing take-up.However, just directing a small share ofLMI refunds to savings bond purchasewould have a substantial impact onsavings bond sales. If just 1 percent ofthe $78 billion in LMI refunds were usedto purchase savings bonds, bond saleswould increase by 10 percent.34

This idea of permitting refund recipientsto buy bonds is an old one. From 1962through 1968, the IRS allowed refundrecipients to receive their refunds in eithercash or savings bonds. This experimentwas apparently not a success, with onlyabout 1 percent of refund recipients usingthe service. This early data may not berepresentative, however, for two reasons.First, low-income filers receivesubstantially larger refunds today than inthe 1960s. Per capita tax refunds have


More importantly,

as a matter of

policy, it would be

desirable to create

a universal “savings

vehicle of last

resort” to ensure

that all willing

savers have an

opportunity to save.


10 august 2005

increased from an average of $636 in1964 (in 2001 dollars) to $1,415 in 2001(Internal Revenue Service [2001, 1964]).35

The majority of low-income families nowoften receive sizable refunds. Second,the historical experiment was an all-or-nothing program and did not allow refundrecipients to direct only a portion of theirrefunds to bonds. Our proposal will bemore appealing since filers would be ableto direct a portion to savings bonds whilereceiving the remainder for currentexpenses.

Other changes in the savings bondprogram would support not only a refund-splitting program, but also a revitalizedsavings bond program. These wouldinclude changing the minimum requiredholding period before bonds can beredeemed; creating a new advertising andmarketing campaign; enlisting additionalsales outlets for bonds; and creating arole for savings bonds as part of afamily’s overall wealth-building activities,as opposed to a stand-alone programdivorced from other savings activities.

The proposed savings bonds are notintended to substitute for private-sectoraccounts offered by the financial sector.Rather, the savings bond alternativeprovides a last resort for families whomthe financial sector would otherwiseignore and provides a base-case productagainst which the private sector couldcompete. If by virtue of this competition,the private sector offered better productsto refund savers, this would be goodpolicy, even if take-up on the savingsbond product itself were minimal.

There are more elaborate versions of ourproposal whereby the refund recipientcould direct the IRS to deposit the moneyin a wider range of alternatives. Thesecould include retirement savingsproducts, discussed by Mark Iwry in anupcoming Retirement Security Projectbrief, or a menu such as offered by theThrift Savings Plan to federal employees.However, giving all refund recipients theopportunity to seamlessly save in the

form of savings bonds could be simple,feasible, and immediate.36 Furthermore,enabling refund-based savings bondpurchases would provide valuableinformation to policy-makers who mightbe contemplating more complex modelsof tax-based savings programs.

Conclusion

Allowing families to direct part of their taxrefunds to a savings vehicle couldtransform tax time into not only a“savable” moment, but also a good timeto intervene to help families take stock oftheir financial lives. Merchants seeking tocapture refund dollars tell potentialcustomers to spend their tax refunds withthem. On April 16, 2005, one of theauthors of this brief received a typicalsales appeal, this one by E-mail fromTravelocity, an online travel service: “Wecan’t think of a better way to celebrate afat refund check than with a fun, relaxinggetaway. Check out some of our favoriterefund-funded ideas below. . . .” We areaware of car dealers who prepared taxesfor free on site, presumably hoping toconvert refunds into down payments.37

Split refunds could help to transform suchappeals toward savings, since firms mightsee tax time as a “point of sale” not forcars and trips, but for financial products.Indeed, tax refunds could encouragefinancial service firms to establish newrelationships with customers whootherwise might appear to be toomarginal to be worth the effort.

In summary, allowing households todeposit part of their tax refunds into asavings vehicle would make the savingsprocess much easier. The results of sucha shift could be particularly beneficial ifthis ease-of-saving were combined withsteps to encourage retention of the funds(potentially including framing the depositsas intended for retirement saving),increased motivation for commercial firmsto encourage saving among middle- andlow-income households, and increasedincentives for these households to save.


Endnotes

1 J. Mark Iwry, “Using Tax Refunds to Increase Savings and Retirement Security,” Retirement SecurityProject Policy Brief, forthcoming.

2 We define LMI as having an adjusted gross income of less than $30,000.

3 Internal Revenue Service, Statistics of Income, “Individual Income Tax Statistics – 2001,” table 3.3 (avail-able at http://www.irs.gov/pub/irs-soi/01in33ar.xls).

4 IRS, “Individual Income Tax Statistics – 2001,” table 3.3.

5 See, for example, Hersh M. Shefrin and Richard H. Thaler, “Mental Accounting, Saving, and Self-Control,”in G. Lowenstein and J. Elster, eds., Choice Over Time (New York: Sage Foundation, 1992); Richard Thaler,“The Behavioral Life-cycle Hypothesis,” Economic Inquiry 26, no. 4 (1988): 133–41.

6 See, for example, Timothy Smeeding et al., “The Earned Income Tax Credit: Expectation, Knowledge, Use,and Economic and Social Mobility,” National Tax Journal 53, no. 4 (2000): 1187–1209; Sondra Beverly et al.,“Linking Tax Refunds and Low-Cost Bank Accounts: Findings from the Extra Credit Savings Program,” WorkingPaper no. 277 (Joint Center for Poverty Research, 2002); Lisa Barrow and Leslie McGranahan, “The Effects ofthe Earned Income Credit on the Seasonality of Household Expenditures,” National Tax Journal 53, no. 4(2000): 1211–43; Jennifer Romich and Thomas Weisner, “How Families View and Use the EITC: AdvancePayment Versus Lump Sum Delivery,” National Tax Journal 53, no. 4 (2000): 1245–66.

7 If an individual files electronically and arranges to have her refund directly deposited into a bank account,she might receive her refund 10 to 14 days after filing. Refund anticipation loans offered by commercial tax pre-parers provide immediate access to cash, but typically charge an effective annual APR of 250 percent in feesand interest (Alan Berube and others, “The Price of Paying Taxes: How Tax Preparation and Refund AnticipationLoan Fees Erode the Benefits of the EITC” [Brookings Institution and Progressive Policy Institute, 2002]).

8 See, for example, Shefrin and Thaler, Mental Accounting, Savings and Self-Control, 1992; Richard Thaler,“Psychology and Savings Policies,” American Economic Review 84, no. 2 (1994): 186–92; Richard Thaler,“From Homo Economicus to Homo Sapiens,” Journal of Economic Perspectives 14, no. 1 (2000): 133–41. Thevery availability of automatic investment plans (which allow workers to deduct money from their paychecks tofund 401(k) and 403(b) accounts) and automatic monthly contributions to mutual funds suggests that the finan-cial industry believes precommitment facilitates saving. Richard Thaler and Shlomo Bernartzi, “Save MoreTomorrow: Using Behavioral Economics to Increase Employee Saving,” Journal of Political Economy 112, no. 1(2004): 164–87; and Ashraf, Nava, Dean S. Karlan, and Wesley Yin. forthcoming. Tying Odysseus to the mast:Evidence from a commitment savings product in the Philippines. Quarterly Journal of Economics describe otherprograms that deliberately used precommitment strategies to encourage saving. Even when formal precommit-ment programs are not available or are not desired, individuals sometimes create their own precommitmentconstraints. For example, some people increase the amount of withholding on their W2 forms to facilitate saving(David Neumark, “Are Rising Earnings Profiles a Forced Savings Mechanism?” The Economic Journal 105 no.438 [1995], 95–106). And at least one study suggests that some low-income workers prefer the lump-sumEITC payment over the advance payment option because it “forces” them to save (Jennifer Romich andThomas Weisner, “How Families View and Use the EITC: Advance Payment versus Lump Sum Delivery,” 2000.)

9 Richard Thaler, “Psychology and Savings Policies,” 1994.

10 Sondra Beverly et al., “Linking Tax Refunds and Low-Cost Bank Accounts: Findings from the Extra CreditSavings Program” (2002).

11 Other community organizations that provide free tax-preparation services have implemented similar pro-grams. To our knowledge, none has been evaluated as carefully as the CEP-Shorebank partnership. Our phoneinterviews with nine free tax-preparation programs and our interpretation of reports from two other tax-prepara-tion programs suggest that the success of these account-opening initiatives varies considerably. The terms ofaccounts vary, with financial institutions occasionally waiving fees, minimum balances, or ChexSystems require-ments. Product marketing also differs across programs. At some sites, bank representatives are on site andactively “sell” the accounts. At others, VITA staff are responsible for selling the accounts and must call into apartner bank to set up the account remotely.

12 Peter Tufano and Daniel Schneider, “H&R Block and ‘Everyday Financial Services,’” Harvard BusinessSchool Case no. 205-013 (Harvard Business School Publishing, 2004).

13 Peter Tufano and Daniel Schneider, “H&R Block and ‘Everyday Financial Services,’” 2004.

14 H&R Block, “Express IRA Accounts and Assets thru FY 2005,” 2005, mimeograph, in possession ofauthors.

15 Esther Duflo, William Gale, Jeffrey Liebman, Peter Orszag, and Emmanuel Saez, “Saving Incentives forLow- and Middle-Income Families: Evidence from a Field Experiment with H&R Block,” Retirement SecurityProject Discussion Paper no. 2005-5, May 2005.

16 An interesting research question is the extent to which such withdrawal restrictions discourage some fromsaving in the first place. The limited literature from 401(k) plans suggests that pre-retirement liquidity has a sig-nificant effect on participation and contribution decisions.

17 Additional information on Vanguard’s splitting policy is available athttp://flagship2.vanguard.com/VGApp/hnw/TcDirectDepositController?cbd (accessed March 3, 2004).

18 This statement is based on phone interviews conducted in March 2004 with representatives from thenation’s 10 largest banks and largest mutual funds by assets.

19 Peter Tufano and Daniel Schneider, “H&R Block and ‘Everyday Financial Services,’” 2004.

20 More detailed information is provided in Sondra Beverly, Daniel Schneider, and Peter Tufano, “Splitting TaxRefunds and Building Savings: An Empirical Test,” Working Paper, 2005 (available athttp://www.people.hbs.edu/ptufano/).

21 CAPTC is a large community action agency based in Tulsa. In addition to providing social services such ashousing assistance, child care, health services, and emergency food and financial assistance, CAPTC providesfree tax preparation to low-income households. In 2002, volunteers completed about 14,300 federal returns.D2D Fund (www.d2dfund.org) is a nonprofit organization focused on the development and testing of innovativefinancial products and services for low-income families. (In the interest of full disclosure, we note that one of theauthors is the founder and chairman of D2D Fund.) BOk is a subsidiary of Bank of Oklahoma FinancialCorporation, which operates banks in Oklahoma, Texas, New Mexico, Arkansas, and Missouri. It is the largestbank in Oklahoma.

22 Beverly, Schneider, and Tufano (2005).

23 We also surveyed their spending and debt-repayment goals, which are not reported here.

24 A person who planned to save to purchase a car and, at follow-up, had done so met this broader defini-tion of success. Someone who planned to save for the future and used part of her refund for an emergencyalso met this definition.

25 Some differences suggest that the comparison group was more advantaged. Members of the comparisongroup were more likely to have higher incomes and to be female, white, and homeowners than R2A partici-pants. Comparison group members were similar to participants with respect to marital status, employment,public benefits receipt, household composition, health insurance, and actual refund receipt. See Beverly,Schneider, and Tufano (2005) for more details.

26 For a discussion of the asset tests, see Zoë Neuberger, Robert Greenstein, and Eileen Sweeney, “ProtectingLow-Income Families’ Retirement Savings: How Retirement Accounts Are Treated in Means-Tested Programsand Steps to Remove Barriers to Retirement Saving,” Retirement Security Project Discussion Paper, August2005.

27 If foiled participants who wanted to split are counted, the (potential) demand for splitting was 21 percent.

28 Wojciech Kopczuk and Cristian Pop-Eleches use 1999 SOI data to report that 67 percent of EITC-eligiblefamilies used a professional tax preparer. See Kopczuk and Pop-Eleches, “Electronic Filing, Tax Preparers, andParticipation in the Earned Income Tax Credit,” Columbia University Working Paper, March 2005,http://www.columbia.edu/~wk2110/bin/efile.pdf (last accessed May 30, 2005). Data on the size of the VITA“market” is drawn from four sources: “Tax Administration: IRS’s 2003 Filing Season Performance ShowedImprovements” (U.S. General Accountability Office, 2003); National Taxpayer Advocate 2004 Annual Report toCongress (IRS Taxpayer Advocate Services, 2004); The Internal Revenue Service, “Tax Stats,”http://www.irs.gov/taxstats/; and The Internal Revenue Service, Statistics of Income, 2001, “Individual incometax statistics – 2001, table 3.3 – 2001 Individual income tax, all returns: Tax liability, tax credits, tax payments,by size of adjusted gross income,” http://www.irs.gov/pub/irs-soi/01in33ar.xls.

29 Internal Revenue Service, Handbook for Authorized IRS e-file Providers of Individual Income Tax Returns,


12 august 2005

http://www.irs.gov/pub/irs-pdf/p1345.pdf (April 2005).

30 J. Mark Iwry, “Using Tax Refunds to Increase Savings and Retirement Security,” Retirement SecurityProject Policy Brief, forthcoming.

31 Peter Tufano and Daniel Schneider, “Reinventing Savings Bonds,” Working Paper, 2005 (available athttp://www.people.hbs.edu/ptufano/)/

32 U.S. Department of Treasury, United States Savings Bonds (U.S. Department of Treasury, 1935).

33 Peter Tufano and Daniel Schneider, “Reinventing Savings Bonds,” Working Paper, 2005 (available athttp://www.people.hbs.edu/ptufano/.)

34 Sales of EE and I bonds in 2004 amounted to $7.9 billion. If 1 percent of the $78 billion in refunds to fami-lies making less than $30,000 per year were captured for savings bond purchase, bond sales would increaseby 9.8 percent.

35 We define LMI filers as those with incomes of less than $30,000 in 2001 or less than $5,000 in the periodfrom 1962 through 1968 (which is approximately $30,000 in 2001 dollars).

36 Since their introduction, U.S. savings bonds have changed in ways that make them less attractive to smallsavers. The bonds have become harder to buy, for example, and less attractive to hold. We make specific rec-ommendations for policy change in another piece (Tufano and Schneider [2004b]). These changes wouldimprove the proposed policy to allow individuals to purchase savings bonds with their refunds.

37 Chi Chi Wu, Jean Ann Fox, and Elizabeth Renuart, “Refund Anticipation Loan Report,” ConsumerFederation of America and the National Consumer Law Center, 2002.


Peter Tufano is the Sylvan C. ColemanProfessor of Financial Management and seniorassociate dean, Harvard Business School, as wellas the founder and chair of D2D Fund, Inc.

Daniel Schneider is a research associate atHarvard Business School.

The views expressed in this paper are those of the authors alone and should not be attributed to the Brookings Institution,Georgetown University’s Public Policy Institute, or The Pew Charitable Trusts.

Copyright®2005

Sondra Beverly is an assistant professor atthe University of Kansas School of Social Welfare.

1755 Massachusetts Ave., NW, Suite 550 Washington, DC 20036

p: 202.483.1370 f: 202.483.1460www.retirementsecurityproject.org

Mission Statement

The Ret i rement Secur i ty Pro ject i s

ded icated to promot ing common

sense so lu t ions to improve the

re t i rement i ncome p rospec ts o f

mi l l ions o f Amer ican workers .

The goa l o f The Ret i rement

Secur i ty Pro ject is to work on a

nonpart isan basis to make i t eas ier

and increase incent ives for middle-

and lower- income Amer icans to

s a v e f o r a f i n a n c i a l l y s e c u r e

ret i rement.

leveraging tax refunds to encourage saving

Economy & Finance