Getting Paid to Save for Retirement

a tax code benefit for lower income folks goes often unused…

Getting paid is always a good thing. Getting paid to save money is even better don’t you agree?

If that’s true, then why are people, who most need to save and who could most use some extra cash, not dingo it?  What I’m referring  to is the Savers Credit, which allows those at lower income levels ($27,750 for singles and $55,500 for marrieds in 2010) to earn as much as a $1,000 CREDIT on their taxes for contributions to retirement plans in addition to taking potential deductions.

And my evidence for this accusation is a recent survey highlighted in Financial Advisor Magazine:

Lower Income Americans Worry Over Taxes

Not only would a young worker being doing something good for their long term financial security, but they could also get paid to do it! Understand also, that this tax credit is in addition to whatever tax benefit the retirement account would normally give, meaning:

1. if it’s a traditional IRA, 401k, or 403b, one could qualify for a tax deduction and the credit

2. if it’s a Roth account, the money could eventually be tax-free and one could still get the credit

Deduction vs Credit

Tax deduction: reduces taxable income so that less income is exposed to the tax rate.  for example, assume 10% tax rate and $30,000 income. This person would normally pay 10% x $30,000 = $3,000 in taxes. If this person put $2,000 into a deductible IRA account, then taxable income would reduce by that $2,000 and this person would pay $30,000-$2,000 = 28,000 x 10% or $2,800 in taxes. result: savings of $200

Tax credit: a tax credit is a dollar for dollar change in what you owe/get back in taxes. If there is a 10%  tax credit on savings, and a person saves $2,000 in their retirement account, their tax bill/refund would decrease/increase directly by $2,000×10% or $200.

Lower income savers can get both of the above! if this is you, you need to take advantage! Also, parents of young workers can help here too. If you plan to help your kids financially, don’t give them money they’ll blow on silly things, give them something that gets real bang for your buck. If your child is, for example, starting her career as a substitute teacher, and earns a salary of $24,000, and you’d like to give her $3,000, look what that’ll do for her (and your gift):

she could put that $3,000 into her Roth IRA, have the money grow tax free and get a $240 credit for her (extra $240 for her than if she took the money and blew it) or

she could put it into a traditional IRA, get a tax deduction producing tax savings of $450 AND the credit of $240 putting $690 extra in her pocket.

Now that’s bang for your buck! Young people, show this to your parents and tell them to drop $2-5k in your IRA for you ok???

Of course I don’t want to give you specific tax advice and retirement advice in this article, but I did want to make you salivate a bit about some opportunities you might be missing.

Schedule a meeting with your tax pro and financial advisor to discuss the possibilities. it would be a shame for this credit to go unused!

For reference:

IRS – Tax Tip 2/21/2011 on the Savings Credit

IRS – Form 8880 for figuring the tax credit