Why You Shouldn’t Direct Deposit Your Tax Refund To IRA

This past Sunday, I came across an article from Humberto Cruz that discussed reasons direct deposit of your tax refund may not be the best idea.

In the event that you were not aware of the recent change, you are now able to have your tax refund sent to an IRA via direct deposit. Last summer, Congress approved a provision of the Pension Protection Act in an effort to increase retirement savings and try to help people that might not otherwise direct the refund towards savings.

Risk: Deadline Approaching
When making a contribution to an IRA, it is possible to make a contribution for the prior tax year up until the filing deadline of the following year. Therefore, you can make a 2006 IRA contribution up until April 17th, 2007. However, as noted in the article, it is not a good idea to try and make that 2006 contribution via direct deposit of your tax refund.

Why not? Quite simply because the tax filing deadline is only 2 weeks away and there is a large risk that your refund, even if filed electronically, will not be processed and deposited until after the 17th. If that were to happen, your 2006 contribution would not be allowed and you would then be faced with filing an amended return to compensate for the mistake.

Risk: Adjusted Refund
The article continues to mention a point that did not even occur to me but is a very valid concern. If you earmark your refund to be deposited into your IRA and also planned to deposit additional funds to maximize your contribution, you could encounter problems if the amount of your refunded is adjusted by the IRS.

If the IRS adjusted the refund in your favor, you could exceed the maximum contribution amount and subject yourself to tax penalties. While not as problematic, if your refund is adjusted to be lower than expected, you would miss out on contributing the maximum to your IRA for 2006. Once the deadline passes for an IRA contribution you cannot *make up* that contribution at a later date, thus this can cost you a considerable amount over the long term.

Risk: Interest Free Loan to Government
The point I agree with most from this article is the idea that too many people revel in receiving a large tax refund every year but find themselves struggling to make ends meet month to month. Rather than continue to provide an interest free loan to the government, adjust your withholdings to increase your take-home pay.

With that money actually coming to you every month, you have the ability to make regular contributions to your IRA or maybe apply the extra funds to eliminate any consumer debt. There is no reason to be stretched too thin every month of the year in anticipation of that tax refund every spring.

Direct Deposit…Just Not To IRA
In closing, I really think that you should utilize the ability to direct deposit your tax refund but just do not do it to your IRA. While I understand the reasons behind this provision approved by Congress, I still think there are a few flaws that have the potential to trip up the people that they are hoping to help.

Be sure to check out the reasons entire article as I think this a great read. I really enjoy the work of Humberto Cruz, maybe I can track him down and interview him for this blog! Humberto, what do you think?