What You Need to Know About Tax Refund Advances
Tax refund advances, often marketed as refund anticipation loans (RALs) or refund anticipation checks (RACs), provide taxpayers with early access to their anticipated tax refunds. While these products may offer quick funds, they come with potential pitfalls that can outweigh the benefits.
Understanding Tax Refund Advances
The most important thing to know is that these refund advances are short-term loans based on your expected tax refund. They are typically offered by tax preparation services in partnership with financial lenders. When you file your tax return, the lender gives you a loan based on the expected refund. That refund is then used to repay the loan once your taxes have been processed by the IRS.
Potential Pitfalls
- High Fees and Interest Rates: Some refund advance loans may come with fees and interest charges that reduce the actual amount you receive from your refund. Even if the loan is advertised as fee-free, it's essential to read the fine print to understand any associated costs.
- Debt Obligations: If your tax refund is less than anticipated or delayed, you may still be responsible for repaying the full amount of the loan, potentially leading to financial strain.
- Delayed Refunds: Errors in your tax return can delay the IRS's processing time, which in turn can delay the repayment of the loan and may incur additional fees.
Tips to Avoid Pitfalls
- File Electronically and Use Direct Deposit: Filing your tax return electronically and opting for direct deposit can expedite the refund process, often eliminating the perceived need for a refund advance.
- Plan Ahead: Anticipate your financial needs during tax season and explore alternative options, such as adjusting your withholding to receive more income throughout the year, reducing the need for a large refund.
- Seek Free Filing and Tax Assistance: Utilize free tax preparation services offered by the IRS or community organizations to avoid unnecessary fees. These services are available through the West Virginia Tax Division or through the Volunteer Income Tax Assistance (VITA), through resources like WVU iServe, Legal Aid WV, and WV Sustainable Families Alliance.
Pros and Cons of Instant Tax Refunds
Like anything in life, there are pros and cons to tax refund advances. The pros include the fact that it provides immediate access to funds, it is usually a simple process, it doesn’t affect your credit score, and there are often low or no-fee options. But be sure to read the fine print to ensure that there aren’t any hidden fees.
However, the cons can sometimes outweigh the pros. It’s important to remember that this is a loan that you have to pay back. Advances are also only for a percentage of your refund, not the total amount. If your refund is less than the predicted amount, you will still have to pay back the entire loan, and fees and high interest rates often apply to this type of loan.
While tax refund advances can provide quick access to funds, it's crucial to understand the associated risks and costs. By planning ahead and exploring alternative options, you can avoid the pitfalls of refund advances and maximize the benefit of your tax refund.
Lauren Weatherford, associate professor and Extension Agent – Fayette and Nicholas Counties
Financial Literacy Education Team