Her Tax Refund Can Be Directed Into an IRA, Divided Among Three Accounts, With One Extra Form

Many taxpayers spend their spring refund on groceries and bills, but a little-known form in the tax rules gives filers another option.

For a lot of households, a federal tax refund arrives in a checking account each spring and is quickly used for everyday expenses. Yet the tax return includes an option most people never use: with one extra form, a filer can send that refund directly into an IRA, or divide it among as many as three accounts. The IRS tool for doing that is Form 8888, a one-page attachment to the return.

One Form Can Turn a Refund Into a Retirement Deposit

Form 8888, officially called Allocation of Refund, instructs the IRS to send all or part of a refund to two or three accounts at a U.S. bank, mutual fund, brokerage firm, or credit union. According to the instructions, eligible accounts can include a traditional IRA, a Roth IRA, or a SEP IRA, though not a SIMPLE IRA. The form also allows deposits into health savings accounts and Coverdell education savings accounts. The amounts listed on its three lines must equal the full refund shown on the return.

What the IRS Says

The rule is spelled out in several IRS publications. The revised Form 8888 instructions list IRAs as eligible accounts. The Form 1040 instructions say a refund can be split and directly deposited into up to three different accounts in the filer’s name. Publication 590-A also says a taxpayer can contribute by having a refund paid directly to a traditional IRA or Roth IRA. At the same time, the tax code caps IRA contributions at the annual limit.

Who Can Use It and Who Cannot

A taxpayer must have earned income, which the IRS refers to as compensation. Publication 590-A says someone cannot contribute in a year they do not work unless they have taxable alimony, nontaxable combat pay, military differential pay, or file jointly with a spouse who has compensation. That joint-filing exception is known as the spousal IRA.

For Roth IRAs, eligibility phases out once modified adjusted gross income reaches certain levels. For single filers, the phaseout range starts at $153,000 and ends at $168,000. For joint filers, it runs from $242,000 to $252,000. Taxpayers who file Form 8379, the Injured Spouse Allocation, cannot have their refund deposited into more than one account. Each account must also be in the filer’s name.

How to Set It Up Before Filing

1. Open the IRA first. The IRS requires the account to already exist before direct deposit is requested.
2. Get the routing and account numbers from the custodian and confirm whether the account should be marked as checking or savings, since the wrong choice can cause the deposit to be rejected.
3. Tell the custodian which tax year the deposit should count toward.
4. Complete lines 1 through 3 of Form 8888 and check the box on line 35a of Form 1040.
5. Keep the IRA deposit within the annual contribution limit.

What the Money Could Become Over Time

The IRS said the average refund for the filing season rose by 11%, though it did not give a dollar figure for that average. As an example, a $3,000 refund invested every year for 30 years at a 6% annual return would grow to about $237,175. Actual returns vary, and that estimate does not include fees or taxes.

Other Ways the Form Can Split a Refund

A filer can also direct part of a refund to an IRA, part to savings, and the rest to checking. On a joint return, the instructions note that each spouse may be able to receive part of the refund and may be able to contribute up to the limit. Each custodian still has to accept the deposit. Buying savings bonds with a refund is no longer available, because the IRS says that program has ended.

Deadlines That Matter

If the taxpayer does not tell the custodian which tax year the money is meant for, the custodian may assume it applies to the year covered by the return. That can send the contribution to the wrong year’s limit. The deposit also must reach the account by the return’s due date, not counting extensions.

If the deposit arrives late, it does not count as an IRA contribution for that year. In that case, the filer would need to amend the return and reduce any IRA deduction and Saver’s Credit claimed. Because most electronic filers receive refunds within about 21 days, filing too late in the season may leave too little time for the transfer to clear.

The refund deposit still must be reported correctly on the tax return. Publication 590-A allows a filer to claim a traditional IRA contribution on a return before the contribution is actually made. Also, no more than three refunds can be sent to the same account in a single year. Contacting the IRA custodian before filing can help confirm the account numbers, the correct account type, and the tax year for the deposit.