Tax refunds for IRAs? How about groceries instead?

Millions of Americans have yet to file their federal income taxes, with the deadline having been pushed back to July 15 from April 15 because of the COVID-19 crisis. And this year, it appears less likely that workers are saving their refunds or using them to fund retirement accounts.

Nearly three-quarters of people who file tax returns receive refunds, at an average of about $2,000. In normal times, most say they use that money to bolster savings, invest or pay down high-interest debt, said Mark Steber, chief tax officer at Jackson Hewitt.

“Surveys show that most taxpayers spend their tax refunds very wisely,” Steber said.

But given the massive spike in new unemployment claims, along with the reduced hours or furloughs many workers are facing, “I don’t think you’ll see as many people putting money into savings or even paying down debt,” he said.

In February, before the pandemic led to a lockdown across the U.S., 50% of people said they planned to use their tax refund for savings, and 34% said it would go toward paying down debt, according to results of a survey of about 7,700 people commissioned by the National Retail Federation. Meanwhile, 24% said they would put the money toward everyday expenses, while 10% said they would use it for a major purchase, another 10% for home improvement, 9% would use it to splurge, and 13% said it would go toward a vacation. (Respondents could select more than one response.)

LIKE A BONUS

While in normal times, tax refunds might be treated like a bonus and socked away, this year they’re more likely to go toward necessities such as groceries and rent.

As of May 22, about 134 million tax returns had been filed, down 6.2% from the 142.7 million that were filed as of that date in 2019, according to the Internal Revenue Service.

However, year-to-date filings are inflated because the total includes returns filed to ensure the IRS had the information needed to send economic impact payments to people who would not ordinarily file income taxes, the agency said.

By pushing the filing date to July 15, the IRS also extended the deadline for IRA holders to make contributions to their accounts for the prior year.

“A lot of people are focused on their finances during what we call tax season,” or January through April, said Melissa Ridolfi, vice president of retirement and college leadership at Fidelity Investments. “About a third, 34%, of our prior year [IRA] contributions come in during those three weeks before the due date.”

IRA providers said there is usually a spike in contributions around the filing deadline, but it’s not clear whether that happened this year. According to Fidelity, contributions to IRAs were up 10% over those seen in the first quarter of 2019, and new account openings were up 36%.

‘LONG-TERM SAVINGS GOALS’

“People are focused on their long-term savings goals,” Ridolfi said. Those savers try to not miss a year of IRA contributions, she noted. But whether people who have saved at high rates will cut back during the second half of the year is in question given the current economic and political environments, she said.

How people used the recent stimulus payments they received under the CARES Act hints at how they might use their tax refunds.

Within 10 days of receiving their checks, people spent an average of $600 more than those who had not yet received checks, according to a recent report from Northwestern University. Spending patterns varied by income level.

During the three days following receipt of payments, spending on basics such as food, utilities, rent and household items increased by $50 to $75 per day, according to the report, suggesting that people were using the stimulus checks on necessities.

A separate report from Betterment showed a difference among active savers. People with Betterment accounts used their stimulus money to fund a cash reserve (27%), build an emergency fund (20%), invest (25%) and save for retirement (13%). Another 15% of Betterment customers used the money for other purposes, including down payments, tuition or future travel, according to the company.

“If you need the money immediately, you might not be putting it into retirement [savings],” said Travis Huber, who is on the IRA team at Wells Fargo.

In normal years, particularly during bull markets, “a healthy number of folks” use IRS Form 8888 to automatically direct their refunds to IRAs, he said.

AN OBVIOUS CHOICE

For those getting refunds who haven’t contributed the maximum to their IRAs for 2019, that can be an obvious choice, at least for people who still have jobs, said Maria Bruno, head of U.S. wealth planning research at Vanguard. And people who did contribute the maximum for 2019 can “get a jump-start on the current year’s contribution,” Bruno said.

Generally, IRA owners who can contribute the maximum to their accounts should do so early in the year, as waiting to make a prior year’s contribution costs them in unrealized compounding — a “procrastination penalty,” Bruno said. Waiting to make contributions can cost $15,000 to $20,000 over 30 years, in today’s dollars, according to research from Vanguard in 2017.

In 2016, two-thirds of IRA contributions at Vanguard were made during the first four months of the year, and most of those made in March and April represented 2015 contributions, the report noted.

‘SUPERSIZING’ A REFUND

Directing refund money to the prior tax year’s traditional IRA limits is appealing, as the contribution itself is tax-exempt, which has the effect of “supersizing” a refund, Steber said.

For some, tax refunds can be put to good use by building emergency savings or put toward necessities, Bruno said. But for people who are financially comfortable, Roth IRA contributions can be a prudent option, she said.

“This whole world is upside down because of the pandemic,” said Marty Abo, a certified public accountant and managing member of Abo and Co. People are less likely this year to “go out and buy cars because they get the tax refund,” he said.

The advice Abo gives on tax withholding, regardless of economic circumstances, is simple: Don’t strive for a big refund, and file sooner rather than later.

“I’m not a big believer in refunds,” he said. “It’s like forced saving.”