The Retirement Saver’s Credit – Cool Cash for Smart Young People

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The Retirement Saver’s Credit sounds like an old person kind of tax credit, but, for the most part, it’s really more of a young person’s credit and it gets totally ignored. The coolest part about the Saver’s Credit is that it’s a credit, not a deduction. That means that it’s a dollar for dollar reduction of your tax liability. A $100 tax credit would reduce your taxes by $100. A $100 tax deduction would reduce your taxes by $10 to $35 depending on your tax bracket. See the difference? Tax credits are better than deductions. The Saver’s Credit is for people with lower incomes so we’re looking at 10 to 15% tax brackets.

The Saver’s Credit can be worth up to $1,000 ($2,000 if you’re married filing jointly), so it’s pretty valuable. Basically, it’s like the government is giving you money for saving for retirement – how cool is that?

Who’s eligible?

  1. You have to be 18 or over
  2. You can’t be a full time student
  3. You can’t be claimed as a dependent by someone else

So what are the income limitations?

  • Single, married filing separately, or qualifying widower – $28, 250
  • Head of Household – $42,375
  • Married filing jointly – $56,500

So what do I have to invest in to get this tax credit? That’s the easy part, you can invest in any of the following:

  1. A traditional or Roth IRA
  2. Most any employer sponsored retirement plan

The one thing that doesn’t qualify is rollover contributions. Also, if you’ve taken money out of a retirement plan, it could reduce your ability to qualify for the credit.

So if I put $1,000 into an IRA the government is going to give me a $1,000 tax credit? No. I said it’s easy, but it’s not that easy. It works on a sliding scale: the lower your income, the larger the percentage you get, somewhere between 10% and 50% of your contribution. The form you need is form 8880. Here’s a link: http://www.irs.gov/pub/irs-pdf/f8880.pdf

Let’s say you’re single, you made $18,000, and you put $2,000 into a Roth IRA. You’d qualify for a $400 tax credit. You can figure that out by looking at the chart and you’ll see you qualify for a 20% tax credit.

The coolest thing about the Retirement Saver’s Credit is that you can play with it. Let’s go back to the example above – you’re single and made $18,000. You have until April 15th to put money into an IRA, so you don’t have to have this all done before tax time. At $18,000 income, you qualify for a 20% tax credit, but at $16,999 you qualify for a 50% tax credit. So if you put $1,001 into a traditional IRA (instead of the $2,000 you were going to put into the ROTH), it will lower your overall income, making your “adjusted gross income” or AGI, $16,999. Now, instead of getting a $400 tax credit on $2000, you get a $500 tax credit on $1,001 – and you still have another $999 left over to save or spend.

So you might be thinking, “Cool, I’ll just put it all into an IRA!” And you can, but you reach a point where the credit doesn’t do you any more good. The Retirement Saver’s Credit is what’s called a “non-refundable” credit. That means that once you zero out your tax liability, you don’t get anything more.

Let’s go back to our example: you’re single, you make $18,000. This time you put the whole $2,000 into a traditional IRA. Now your AGI is $16,000, that means your taxable income is $6,500 and your tax liability is now $658. So you complete form 8880 and you see that you qualify for a 50% credit which is $1,000 but since your tax liability is only $658—that’s all the credit you get.

Now if you have $2,000 to put into savings, I am 100% behind you saving the full $2,000. But, you may be better off putting some of that money into a regular savings account instead. It’s something to play with. Never sneeze at a 50% return on your investment. Let’s be real, that’s what this is. Even the 10% and 20% return is a good deal. But once you’ve maxed out that return, then you need to look at what other options you’ve got. That’s why I like IRAs. You can figure out your tax return first before make the investment. The absolute best part – you can make the investment with your income tax refund! You can actually do your tax return, plan out your IRAs, and not fund them until after you’ve gotten your refund.

Not everyone will qualify for the Credit for Qualified Retirement Savings Contributions, but if your income is anywhere close, you’ll definitely want to at least look into it.

Tax Tips for Single People

 

Singles need tax breaks too.

 

If you’ve skimmed through my other blog posts, you might notice that I have lots of tips for people with children, people who are old, or people with various family situations.  What you don’t see is much about people who are single and working.  This post is for you.

 

If you’re a young adult out on your own, earning wages, and living in an apartment, you’ve probably noticed that you don’t have many tax deductions to work with.  The three most likely things you might qualify for are the student loan interest deduction, the IRA deduction, and the retirement savings contribution credit.  Other than that, unless you’re ready to buy a home, you usually don’t have much to work with.  But let’s take a look at these three items.

 

Student loan interest deduction:  if you’ve finished college, or are at least temporarily out, you’re probably paying student loans.  The most you can claim per year for this deduction is $2,500—now that’s for the interest you pay, not the principal.  I often find people trying to claim everything they paid and that won’t fly.  You can only use the amount on your form 1098E that you get in the mail.

 

Now if you’re single and you make less than $60,000 per year, then you can claim the full amount of your deduction.  If you make over $75,000 you lose the deduction completely.  For those of you inbetween, you’re in what’s called the phaseout range.  It’s a funky equation, bottom line, the closer you are to $75,000, the less you’ll be able to claim.

 

IRA deduction:  My Dad always used to lecture me about saving for retirement.  Now that I’m older, I just recycle his lecture. (I’m sure he doesn’t mind.)  If you don’t have a retirement plan at work, you can put up to $5,000 into a traditional IRA and that money will not be subject to income tax.    Let’s say your income was $50,000 a year.  With just your standard deductions, your total tax would be $6,350.  (Now hopefully you’ve been withholding all year and you wouldn’t have to pay in that much, that would be your total tax liability.)

 

But if you put $5,000 into an IRA, then your tax liability would go down to $5,100.  By saving money for your retirement, you’d also save $1,250 off of your tax bill.  That’s a pretty good bang for your buck.

 

If you do have a retirement plan at work, you can just reduce your taxable income by putting money into your 401(k) plan there.  It works a lot like the traditional IRA.  One thing to remember, if you do have a retirement plan at work and you make over $66,000 then you won’t be able to claim a deduction for an IRA contribution.  You can still claim a full deduction if you make less than $56,000, and anything in between puts you into that “phase out category”.

 

Retirement Savings Contribution Credit:  Putting money away for retirement can be especially helpful taxwise if you qualify for the Retirement Savings Contribution Credit.  You can only claim this credit if you income is $27,750 or less though and you cannot be a full time student.  So, if you graduated in May and started working in June you wouldn’t be able to claim the Saver’s credit this year.  (But then we’re looking at the Education credit so that’s usually a better deduction anyway.)

 

The credit is worth between 10% and 50% of your retirement savings contribution.  The maximum contribution you can claim is $2,000—so even if you put $5,000 into your IRA, you could only claim $2,000 towards the credit.   The percentages work like this; if you made less than $16,750 you can claim 50% of your contribution.  Up to $18,000 you claim 20%, and over that you get a 10% tax credit.

 

So let’s say you made $25,000 and put $1,000 into an IRA.  You’d qualify for a $100 tax credit (1,000 times 10% is $100.)  Another cool thing about this credit is that you can mess around with it.  Let’s say that you make $28,000—oops, you can’t get a Saver’s Credit.  But wait, if you put $1,000 into an IRA now your income is only $27,000 and you do qualify.

 

You don’t get a lot of tax savings options when you’re working and single, but it’s important to know what is available to you and how to make to most out of what you’ve got.