What is a Tax Refund Anticipation Loan (RAL)?
A tax refund anticipation loan is loan offered by a third-party company against a taxpayer's expected income tax refund.
How a Tax Refund Anticipation Loan (RAL) Works
When individuals file their income tax forms for the year, they may find that they are entitled to a tax refund. Tax refunds return the excess amount of income tax that a taxpayer has paid to the state or federal government during the past year, typically through withholding from a paycheck. In the United States today, the majority of taxpayers receive income tax refunds.
The U.S. Treasury issues refunds in the form of government checks, U.S. savings bonds, or direct deposits to the taxpayer's bank account, depending on what the taxpayer has requested. Most refunds are issued within a few weeks after the taxpayer submits his or her tax return for the year to the Internal Revenue Service (IRS), the bureau of the Treasury Department that is responsible for collecting taxes. Direct deposit is generally the fastest method to receive a refund.
A tax refund anticipation loan (RAL) is marketed as way for the taxpayer to receive his or her money even more quickly. Such loans are not provided by the U.S. Treasury or the IRS, but by third-party companies, and they are subject to the interest rates and fees set by the lender. Tax refund anticipation loans are most often offered by large tax preparation companies to taxpayers who are expecting refunds of a few thousands dollars or less.
The government pays most tax refunds within a few weeks, so taxpayers who don't need their money immediately gain little benefit from a refund anticipation loan.
Pros and Cons of a Tax Refund Anticipation Loan
With a tax refund anticipation loan, an individual can get quick access to a sum of money based on his or her expected tax refund. But because taxpayers will typically receive their refunds from the government within a few weeks, anyway, borrowing that money usually makes little financial sense, unless the taxpayer is in immediate need of the funds.
A major reason is that refund anticipation loans can be a very expensive form of borrowing, especially considering the short-term benefit they provide. If the lender charges interest, the quoted rate may seem small, generally around 3% to 5% of the refund amount. However, the total cost can be much higher when additional fees and charges are factored in.
Finally, while many people see a tax refund as forced savings or a nice bonus at tax time, they might want to view it another way. That is, the bigger their refund, the more money they have been lending to the government, tax free, during the past year.
As an alternative, taxpayers might consider adjusting their federal and state tax withholding so that their employers withhold enough money from their paychecks to cover their likely tax obligations for the year, but not so much as to produce a large refund. By doing that, taxpayers who have the discipline to save that extra income can put it aside for future use – possibly eliminating the need to even think about a tax refund anticipation loan.