LET UNCLE SAM SUBSIDIZE YOUR RETIREMENT SAVINGS

Posted by Bruce Mc on Sep 24, 2008 in Form 1040 Information, Taxes, Things forgotten | 0 comments

{OOPPPs! Didn’t tell you, The Wondering Tax Pro and I have decided to switch our compatible/complimentary posts spots. Meaning TWTP’s discussion of the Credit for Qualified Retirement Savings Contribution appears here at taxguy and my post on this, appears over at  TWTP titled ANOTHER CREDIT – FORM 8880.- This is a small break from my series. Enjoy.}

LET UNCLE SAM SUBSIDIZE YOUR RETIREMENT SAVINGS

by Robert D Flach – The Wandering Tax Pro

TAX GUY Bruce has provided a good overview of the Retirement Savings Contributions Credit, aka “Saver’s Credit” in his post “Another Credit – Form 8880″ which appears today over at THE WANDERING TAX PRO.

The recent Ninth Annual Transamerica Retirement Survey revealed that only 17 percent of full-time American workers with annual household incomes of less than $50,000 are even aware that the credit exists.

Recent surveys report that nearly half of American households are not saving at all for retirement and two thirds are not saving enough. This credit, which was first introduced in the Economic Growth and Tax Relief Reconciliation Act of 2001 and made permanent by the Pension Protection Act of 2006, is an excellent way to get low income individuals and those just starting out in the workplace to save for their retirement.

Under this credit a lower-earning individual can get the federal government to subsidize from 10% up to over 80% of his/her retirement savings, depending on the individuals AGI and tax situation.

For 2008 the Modified AGI amounts for determining the Retirement Savings Contribution s Credit are:

SINGLE, MARRIED SEPARATE, QUALIFYING WIDOW(ER)

$ 0 – $16,000 = 50%

$16,000 – $17,250 = 20%

$17,250 – $26,500 = 10%

HEAD OF HOUSEHOLD

$ 0 – $24,000 = 50%

$ 24,000 – $25,875 = 20%

$ 25,875 – $39,750 = 10%

MARRIED FILING JOINT

$ 0 – $32,000 = 50%

$ 32,000 – $34,500 = 20%

$ 34,500 – $53,000 = 10%

To determine “Modified” AGI for purposes of this credit you start with AGI and add back any exclusion or deduction for foreign earned income, foreign housing cost, and income from American Samoa or Puerto Rico.

Let us look at an example of how this credit works –

Jane Q Taxpayer, a single parent with one dependent child, will earn $24,963 in taxable W-2 wages for 2008. This is her only taxable income for 2008. She does not contribute to a 401(k) or other pension plan at work.

If Jane were to contribute $1,000 to a traditional IRA for 2008 she would be able to claim a deduction for the contribution on her 1040A. This $1,000 would reduce her AGI to $23,963. As a Head of Household with a “Modified” AGI of less than $24,000 she is eligible for a full 50% Retirement Savings Contributions Credit on her $1,000 IRA contribution.

By making a deductible contribution to an IRA Jane saves $100 in federal income tax (10% tax bracket) and gets a credit of $500 – a total savings of $600. So “Sam” has paid 60% of the IRA contribution.

Jane could file her return early in the season so that her refund would arrive before April 15^th and she could use part of her tax refund to fund the IRA contribution.

If instead of an IRA contribution Jane participated in her employer’s 401(k) plan and made a total of $1,000 in employee contributions to the plan she would realize an additional $160 savings from an increased Earned Income Credit (the EIC is based on taxable W-2 wages, which would be reduced by her $1,000 contribution to the company plan). Now 76% of her retirement savings has been “subsidized” by “Sam”.

If Jane had two dependent children the EIC savings from a $1,000 contribution to her 401(k) would save $211 – bringing the government subsidy up to 81.1%.

Jane could revise her W-4 withholding so that the 401(k) contributions did not reduce her take-home pay. On her limited income she could not afford to lose $1,000 in income, but she could handle $189.00.

In the above cases Jane would recognize the tax savings as an increase in her refundable Child Tax Credit.

Unfortunately if your standard or itemized deduction(s) or dependents wipe out the tax liability you get no benefit from the Savers’ Credit. It is not a refundable credit (we have enough of those already) and cannot be carried forward.

The most difficult year to start a retirement savings account is the first year you begin work. This is also the best time to begin. If you can discipline yourself to do it as soon as you start to work it will be easier to continue each year thereafter. The Retirement Savings Contributions Credit can help to reduce the actual cost of your first year’s contribution.

Here is another example –

John Q Taxpayer (who is over age 17) graduated from school in 2007. He started a full-time job in 2008 and will receive taxable wages of $17,350 for the year. He will also have $25 in bank interest for 2008. His tax liability would be $863.

If John Q contributes $1,406 to a deductible IRA his AGI would now be $15,969 and he would be eligible for a 50% credit. His tax liability would be “0″. John Q is “out of pocket” only $543. “Sam” has paid for over 61% of his retirement savings. As in the earlier example, John Q can use all or part of his resulting tax refund to fund the contribution if he files his return early enough in the season.

Of course John Q could contribute more than $1,406 to an IRA. He could contribute $2,000 and treat $594 as a nondeductible contribution on Form 8606. Or he could contribute $1,406 to a traditional IRA and up to $3,594 to a ROTH IRA.

Here is another idea. John Q’s parents and/or grandparents could gift to him an IRA of $1406 or more. In addition to giving him a start on a retirement account for the future they are also putting an additional $863 in his pocket, which he could contribute to his IRA for 2009.

TTFN

{The series I started will continue on Friday with a Guest post from Gina please visit her blog (Tax Tips Blog) http://glgcpa.com/blog}

Again, I want to invite any and all guest post on this subject. I want to hear from all bloggers or just readers with their own input. Let’s see what you see I am missing. If you have some words of wisdom on this subject please let us share it with everyone, if it is something that has already been covered, so what, I am looking for others to tell what they know or have learned about finding a paid preparer. Repetition drives the point home.