The IRS’s Secret, Successful Low-Income Savings Program
Thursday, April 16, 2015
While April 15th is generally referred to as “tax day,” that’s true for less than 20 percent of filers. For most working households tax day falls in February or early March. It’s the day when they receive their refunds, not when they file.
More than 80 percent of filers making less than $50,000 a year get a refund. Those refunds are more than $2,000 on average. There’s a lot of handwringing over those figures: Financial advisers urge people not to give the government an interest-free loan, and instead reduce their withholding and set-up an automatic savings plan. (It’s worth noting that many low-income households couldn’t follow that advice even if they wanted to, because they don’t have access to free savings accounts, ore ven to jobs that offer steady pay and automatic savings options.) Meanwhile, social service agencies run programs that encourage households to put their refunds into long-term savings and rainy day funds. They worry that the households are missing a chance to build assets and economic stability. That’s a legitimate concern when 60 percent of households have less than three months of liquid savings, and emergencies like a vehicle breaking down, a job loss, or an unexpected cut in hours is likely. But neither the financial advisers nor the social service agencies have had much luck changing behavior, based on historical IRS data and surveys of household emergency savings.
Thinking about tax withholding and refunds in a different light suggests a course of action that may be more likely to help lower-income households improve their financial situation. Overwithholding—choosing to withhold more than you will owe to get a refund—is a wildly successful savings program.
Over the last decade, behavioral science researchers have shed light on why it is so hard to save despite good intentions and how we can stack the deck in savers’ favor. One of the outcomes of that work is the value of a “commitment savings” account. These are savings accounts that people voluntarily open, but cannot access until they accumulate a certain amount or reach a specific future date. It provides all the benefits of accumulating a big chunk of cash without any of the painful and exhausting daily resistance to temptation.