Thinking About a Tax Refund Loan?

The formal name is refund anticipation loans, or RALs.  They're marketed primarily to cash-poor taxpayers who use their annual federal and state tax refunds as a piggy bank for discretionary items or increasingly, essentials like food and rent.

Do they make sense? Ask yourself this question – would you borrow money at rates well in excess of 40 percent with additional fees at a minimum of 10 percent or higher just to get your hands on money that you could have in your possession the previous 12 months?

Let's go a step further. The Consumer Federation of America and the National Consumer Law Center reported last year that RALs cost the average borrower from about $30 to over $125 in loan fees. Some tax preparers also charge a separate fee, often called an "application" or "document preparation" fee, of about $40. The agencies added that the effective annual interest rate (APR) for a RAL can range from about 40 percent to over 500 percent, and if application fees are charged and included in the calculation, the effective APRs range from about 57 percent to over 1,100 percent.

Granted, the leaders in the field have been forced to cut their rates and fees under pressure – No. 1 H&R Block says its fees now average two percent of the principal on each loan. But why even bother with that?

In the tax refund loan game, there are really two issues. First, there's what borrowers pay for something they could get interest- and fee-free a few weeks later. Second, there's the issue of tax planning that could eliminate the need for such loans in the first place.

If you're working with a tax advisor or a financial planner such as a CERTIFIED FINANCIAL PLANNER™ professional, they'll tell you that the best way to put cash in your hand is through tax planning, not overpayment of tax so you can get a check later.

It's been said that tax refunds are really interest-free loans to the government, and it's true. The benefit of working with a qualified tax professional or a financial planner is that they might have more incentive to lead you in the direction of sensible tax strategies than a tax preparation firm that offers such loans. Why would any firm offer smart tax advice when it might threaten such a huge revenue stream?

Want to put extra money in your pocket all year round, not just at tax time? Consider the following steps:

Make this the year you do some real tax planning: Qualified tax professionals such as certified public accountants (CPAs), enrolled agents (federally licensed individuals who have passed a comprehensive Internal Revenue Service exam) or a tax attorney can help you devise a strategy so you and Uncle Sam don't owe each other anything at tax time.  You'll do this through smart withholding and finding legal deductions that might create tax savings. Many individuals can get by with the help of an enrolled agent or CPA, and while there are many tax attorneys who do individual returns, they are typically used for business returns or more complex individual tax situations

Restructure your spending: Maybe if you knew where your money was going each day you wouldn't have to pay extreme rates and fees to score extra cash at tax time. A financial planner can give you some critical advice in building a budget that fits you and your income and spending picture, or you can make this the year when you buy a financial tracking program for your computer and start typing in your daily spending – that activity alone will be an eye-opener.

Rethink the whole instant gratification thing: Yes, it's fun to think about the big-screen TV or the weekend package in Vegas you might splurge on with your tax refund, but if you're still addicted to getting one every year, why not use it to deposit a little extra in an IRA? Finish your taxes early enough and you'll be able to get an extra bump in your retirement for the 2007 tax year. This is a good year to make a fresh start in your relationship to saving and spending.