Does Uncle Sam Want To Donate $2,000 Toward Your Retirement?
Free money from the federal government to save for retirement may sound too good to be true. But a provision of the tax code could effectively put up to $2,000 in your retirement accounts. To see if you can take advantage of Uncle Sam’s largesse, read on.
I know it may seem odd, especially if you’re inclined to think of the tax man less as a giver than a taker. But by claiming a tax break known as the Saver’s Credit, singles and heads of households who contribute to a 401(k), IRA (traditional or Roth) or similar retirement account may qualify for a tax credit of as much as $1,000, while married couples filing jointly may be able to snag a credit of up to $2,000, in effect making the federal government a partner in building your retirement nest egg.
The amount of the credit is 10%, 20% or 50% of a contribution to a retirement plan or IRA of up to $2,000 for singles and heads of households and $4,000 for married couples. That translates to a tax credit of $200, $400 or $1,000 for individuals contributing $2,000 to a retirement plan and $400, $800 or $2,000 for couples stashing away $4,000. To qualify for the credit for the 2014 tax year, contributions to a 401(k) account must be made by the end of the year; you can contribute to an IRA as late as April 15th.
This program is a creature of the federal government, which means you must jump through a number of hoops to qualify. For starters, you must be 18 or older, you can’t be a student and you can’t be claimed as a dependent on another person’s tax return.
The credit isn’t “refundable,” which means it can’t exceed the amount of tax you owe. Your Saver’s Credit could also be reduced or eliminated if you’re already taking advantage of other nonrefundable tax credits, such as the credit for child and dependent care expenses.
But the big hurdle for most people is income. To qualify for the Saver’s Credit this year, your adjusted gross income can’t exceed $30,000 if you’re single, $45,000 if you’re the head of a household and $60,000 if you’re married and filing jointly. To get the maximum 50% credit, the respective ceilings are $18,000, $27,000 and $36,000.
Don’t be too quick to blow this off just because the income ceilings may seem low. Why? Well, for one thing, these are limits not on gross earnings but on your adjusted gross income, or AGI. To arrive at your AGI, you deduct from your pretax salary any contributions to a traditional 401(k) and/or traditional IRA. So if you’re not too far above the maximum allowable AGI for the credit, you may be able to help yourself slip below the cutoff by putting money into a traditional 401(k) or traditional IRA, or stashing away more dough if you’re already contributing.
Just remember that if you’re counting on a retirement account contribution to lower your 2014 AGI, you must make that contribution this year, and it’s got to be a contribution to a traditional 401(k) or deductible IRA. Contributions to Roth accounts qualify for the credit, but they don’t lower your AGI.
Even if you can’t squeak in for the credit this year, you might in later years as the qualifying AGI rises (which it does for 2015) or if your income drops, which may very well be the case after you retire (although you would still need earned income to contribute to a retirement account).
Besides, even if you’re not elibible for the credit, you may want to let a friend or relative whose income may be low enough to qualify know about it. Who knows, the prospect of a few free bucks from Uncle Sam just might persuade an adult son, daughter or grandchild who hadn’t planned to save for retirement to do so—or spur someone who’s already contributing to a retirement account to save more.
Finally, I’m sure there are people out there thinking, “Hmm. I can contribute $2,000 to a Roth IRA this year, claim a $1,000 credit, withdraw the Roth contribution tax-free next year, contribute again, take the credit again and repeat that year after year, racking up annual $1,000 credits with the same contribution.”
Nice try, but no go. The rules require that distributions from retirement accounts in recent years be deducted from new contributions, preventing anyone from gaming the system this way.
So take a few minutes to see whether you or someone you care about might be able to reap a few bucks from the Saver’s Credit. Even if the benefit is small—a few hundred bucks or less—it’s worth doing. After all, as you can easily see by revving up this Will I Have Enough To Retire? calculator, every extra dollar you can save—and earn a tax-advantaged return on—can only enhance your retirement security down the road. (11/25/14)
Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at email@example.com.