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Contributors to retirement plans
already know the long-term tax advantages of an IRA or 401(k). Taxes
are deferred, and in some cases never collected, on money put away
for the golden years.
Now, a tax credit will let some savers reap the rewards
of their retirement thrift early.
The retirement savings tax credit (also
called the saver's credit) appears on both the 1040
and 1040A tax returns as a way to reward lower-wage
earners who sock away retirement money.
Since the tax break is a credit instead
of a deduction, it's a better deal. Tax deductions reduce
taxable income, but credits come in to play after you
calculate how much tax you owe and reduce your Internal
Revenue Service bill dollar for dollar. For example,
if you owe $500 and you are eligible for a $250 credit,
the check you have to write to Uncle Sam is cut in half.
Income
limits
A filer eligible for the saver's credit could
shave as much as $1,000 off his tax bill. The actual
credit amount depends upon your income, filing status
and just how much you put into retirement plans. Basically,
the lower your income, the bigger your credit. The precise
credit percentages are:
 |
Retirement savings credit guidelines |
|
| 50% |
Up
to $15,000 |
Up
to $30,000 |
Up
to $22,500 |
| 20% |
$15,001
to $16,250 |
$30,001
to $32,500 |
$22,501
to $24,375 |
| 10% |
$16,251
to $25,000 |
$32,501
to $50,000 |
$24,376
to $37,500 |
| No
credit |
$25,001
or more |
$50,001
or more |
$37,501
or more |
As the table shows, the maximum available
credit is 50 percent of contributions for filers in
the lower end of the earnings ranges. There is, however,
a limit on the contribution amount you can use to figure
the tax break.
Although tax law allowed you to put up
to $4,000 in 2006 ($5,000 if you're age 50 or older)
in your IRA, only $2,000 of that will count in figuring
the saver's credit. That makes it worth at most $1,000
for single taxpayers. Of course, if you're married and
both you and your spouse put away at least 2 grand toward
retirement, your joint return would reflect a $2,000
credit.
Which
contributions count?
Contributions to traditional and Roth IRAs as
well as to employer-sponsored 401(k) plans
count toward computing the credit. So does money you
put into a Savings Incentive Match Plan for Employees,
or SIMPLE, plan; a 403(b) annuity; a governmental 457
plan, or a salary reduction Simplified Employee Pension,
or SEP. You can only count the money you put in your
workplace account, not any matching amounts your company
contributed.
The credit is based on your total contributions
to all your eligible retirement accounts, not for contributions
to each. So if you put $2,000 into a Roth and another
$2,000 into your 401(k) at work, you still can only
calculate your credit on the allowable maximum of $2,000.
Enter all your retirement saving amounts
on Form
8880, Credit for Qualified Retirement Savings Contributions,
and complete the form to arrive at your exact credit
rate and amount. Once you get the dollar amount, transfer
it to line 51 of your 1040 or line 32 if you file the
1040A. (The credit isn't available for 1040EZ filers,
so you might want to consider changing
your choice of returns if you've been putting away
retirement cash.)
If your IRA contribution is to a traditional
account, you may be able to get a double tax break.
In addition to the saver's credit, look into whether
you're eligible to deduct
your IRA contributions on the front page of your
1040 or 1040A. This tax break is one of several adjustments to income that are available to all taxpayers, regardless of whether itemizing or taking the standard deduction, and the IRS
says you can claim both the retirement savings credit and deduction for
your IRA contributions.
The credit also is attractive to workers
who are eligible to participate in a 401(k)
plan but who earn just over one of the saver's credit
income limits. By signing up for a company-sponsored
account, such workers could get under the earnings cap
while simultaneously boosting the potential credit amount.
Take, for example, a married employee
who is the sole earner in her family and who reports
adjusted gross income of $32,000 on her joint tax return.
She's already eligible for a partial credit, but by
contributing $2,000 to her 401(k), she
will knock her income down enough to take the maximum
credit.
Some
other restrictions apply
In addition to the income limits, there are
a few other restrictions on who can claim the saver's
credit. A taxpayer who was younger than 18 last year,
a full-time student or claimed as a dependent on another's
tax return can't take the retirement savings break.
The saver's credit is also what the IRS
calls nonrefundable. That means you can use it to reduce
your tax bill to zero, but you can't take advantage
of any excess credit amount to get a refund. So if you
owe no taxes, the credit is of no use to you.
Still, even if you can't take full advantage
of the credit, it's not too shabby of a break when you
take into account the additional tax savings you get
by contributing to a retirement account in the first
place.
Just remember, the key to this credit
is participation in retirement accounts. If you haven't
opened a retirement account yet, or have one but haven't contributed for the 2006 tax year, you have until the April 17 deadline to open and put in money. The deadline is the same for either a Roth or traditional IRA.
As for your 401(k), you're
locked into your credit for the 2006 tax year based
on the contributions you made last year. Make sure the
W-2 you got from your company reflects the correct amount
of all your pension contributions so that you can get
the maximum credit.
If you're not yet participating in your
company plan, you can improve your future saver's credit
potential by signing up as soon as you're eligible.
Then contribute as much as you can afford without doing
major cash-flow damage to your paycheck. It could pay
off at tax-filing time.
Freelance writer Kay Bell writes
Bankrate's tax stories from her home in Austin,
Texas, and blogs on tax topics at Don't
Mess with Taxes.
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