Most people are not aware of the Savers Tax Credit whereby the federal government will pay you for contributing to your 401k plan, IRA, Roth IRA, SEP, SIMPLE, 457, 403b or other similar retirement plans. This program is designed to encourage lower income individuals and families to invest in retirement plans so as to make them less dependent upon government plans during their retirement years.
Here’s how it works:
You contribute to a qualified retirement plan such as a company 401k plan and then when you file your tax return you apply for the savers tax credit. The amount of your tax credit depends on your marital status and income. Remember, a tax credit is different than a tax deduction. If you get a $1,000 tax credit, that full amount is either sent to you directly from the federal government or applied dollar-for-dollar against income taxes you owe. The Savers Tax Credit is limited to a dollar limit of $1,000 ($2,000 for married couples filing jointly). The lower your income, the higher the tax credit. Take a look at how the limits work:
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Adjusted Gross Income (AGI)
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Joint return
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Head of a household
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All other cases
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Applicable Percent
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Over
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Not over
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Over
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Not over
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Over
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Not over
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$0
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$34,000
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$0
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$25,500
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$0
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$17,000
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50
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34,000
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36,500
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25,500
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27,375
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17,000
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18,250
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20
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36,500
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56,500
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27,375
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42,375
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18,250
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28,250
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10
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56,500
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—
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42,375
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—
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28,250
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—
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0
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In addition to the income limitation to be eligible for this tax credit, you also must be at least age 18 during the tax year; not be a full-time student; and not be claimed as a dependent on another person’s return.
Let’s look at a couple of examples:
You are married filing jointly with adjusted gross income of $32,000 and contribute $4,000 to a tax deductible IRA. You’ll not only receive a tax deduction for your contribution, you are eligible for a $2,000 income tax credit which you can receive as part of your tax refund or apply to income taxes due. In this same example, if you contribute $5,000 to your deductible IRA, your tax credit is still limited to $2,000, the maximum available to joint filers.
Taking advantage of the savers tax credit is especially important if you work for a company that offers a matching contribution to your 401k plan. Let’s say your employer offer a dollar-for-dollar match up to 6% of employee compensation. If you contributed $1,900 (6%) of your $32,000 compensation, you’d receive a $1,900 company matching contribution plus an $850 tax credit from Uncle Sam. Total return on your $1,900 investment for that year is $2,750 or a whopping 145%! Now that’s what I call a great investment!
Take a moment to think about working family members, children, grandchildren and friends for whom this strategy might apply. If you’re a parent or grandparent making cash gifts, could you use this strategy to leverage the value of your gift?