Contributing to a retirement account can be difficult for lower income households, but one can argue that it is even more important for those families to take advantage of all the retirement savings options that are possible. One of the lesser-known options applies directly to lower-income families – the retirement savings tax credit.
The credit applies to most retirement plans – 401(k)s, IRAs (both Roth and Traditional), 403(b)s, 457(b)s, SIMPLE IRA’s, SARSEPs, and other plans. It does not apply to rollover contributions, and any recent distributions that you received from these plans can reduce the amount of your credit.
A tax credit of up to $1,000 is possible on $2,000 in contributions (or $2,000 credit on $4,000 in contributions if married filing jointly). Even better, for traditional 401(k) and IRA plans, you can also claim the deduction for contributing as well as receiving the tax credit – so you benefit on your tax form both above and below the line. (For Roth IRA’s, you can only receive the credit, but not a tax deduction since Roth IRAs use after-tax dollars).
The credit is scaled by income and eligibility is capped by limits on Adjusted Gross Income (AGI), which for tax year 2014 are $60,000 for married filing jointly, $45,000 for head of household, and $30,000 for all other filers. A full 50% of the contribution can be claimed if the income is under $36,000 for married filing jointly, $27,000 for head of household, and $18,000 for all other filers. There are also income thresholds for 20% and 10% contribution for each category. Amounts are adjusted annually for inflation.
This tax credit is non-refundable, so if other credits have already wiped out your tax liability, you will not be able to claim this credit.
To qualify, you also need to be at least age 18 and not a full-time student or claimed as a dependent on someone else’s tax return. You are considered a full-time student if you were enrolled as such during part of any five calendar months (effectively a semester). Mechanical, technical and trade schools are all included within that definition, but on-the-job training and correspondence or Internet-only schools do not.
Make sure that your contribution takes place in the correct tax period. For IRAs and plans not associated with the workplace, you have up until the filing deadline for a particular tax year to make the contributions (in other words, you can contribute until April 2015 and count it on your 2014 taxes). For 401(k)s and other workplace plans, contributions generally needs to take place within that calendar year.
For further details on qualifications, see IRS Form 8880, “Credit For Qualified Retirement Savings Contributions”. The instructions walk you through the figuring of the credit and the credit limit worksheet, as well as all of the qualifications and limitations.
A 2013 study from the Transamerica Center for Retirement Studies noted that only 23% of households with annual incomes of less than $50,000 were aware of this tax credit. Sadly, these are the people who are most likely to qualify for and claim this credit.
If you are in this lower-income range, it is even more important that you check out all of your options for tax credits – not only the retirement savings credit, but also any others that apply to your situation. However, because of the triple benefits of tax credits, deductions from taxable income in most cases, and an increase in your tax-deferred retirement accounts, the Retirement Savings Tax Credit should be on the top of your list.
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