Your rich Uncle (Sam, that is) wants to help you save for your retirement. In fact, through the tax code the US Government has done several things to help pick up the tab for your retirement savings. I’ll review a couple that you may already be familiar with and then I’ll talk about an additional way good ole Uncle Sam helps low to moderate income earners save for retirement. We’ll start with the review…
- TSP. You can contribute to TSP (a 401k or 403b if you’re not in the military or government) and reduce your taxable income by up to $17,500. When you contribute to TSP the money that goes into TSP is never included in your income. In other words, Uncle Sam contributes somewhere between 10% and approximately 35% of the amount that goes into TSP. For example, if you contribute $10,000 to TSP and you are in the 15% marginal tax bracket, Uncle Sam provides $1,500 of the contribution (your taxes go down $1,500). Also, since the money you contribute to TSP is not included in your income the contribution reduces your Adjusted Gross Income (AGI). AGI controls the amount of other deductions and credits that you can claim. So, keeping AGI down is very important to controlling your overall tax burden. Earnings in TSP grow tax deferred as well, which should give you more available money when you retire.
- Traditional IRA. Much like TSP, you can also contribute to a Traditional IRA. If you are not covered by a retirement plan at work, then IRA contributions (up to $5,000 annually) are excluded from your AGI, just like TSP contributions. The IRS considers Active Duty Military Members to be covered by a retirement plan (Reservists may or may not be depending on the exact circumstances) so you will only be able to deduct your IRA contributions if your Modified AGI is less than $110,00 for Married Filing Jointly or $66,000 for Single or Head of Household. The deduction is subject to phase out and the numbers sited are the top limit (See IRS Pub 590 for more details). For spouses of military members, if they are not covered by a retirement plan the Modified AGI limit increases to $179,000 so in most scenarios a military spouse will be able to deduct a contribution to a Traditional IRA assuming the spouse is not covered by a retirement plan at work. If you cannot deduct the IRA contribution you can still contribute to a Traditional IRA and gain the benefits of tax deferral. But rather than making a non-deductible contribution to a Traditional IRA you might want to contribute to a Roth IRA
- Roth IRA. Roth IRA contribution limits are the same as a Traditional IRA. Roth IRA contributions are not tax-deductible but all proceeds from a Roth IRA are tax free to the recipient. Roth IRAs also can have advantages for estate planning and the taxation of Social Security Benefits in retirement, but that is more than we can cover in this article. If your income is too high ($179,000 if Married Filing Jointly or $122,000 for Single or Head of Household) you won’t be able to contribute to a Roth IRA. Again, see IRS Pub 590 for details.
Uncle Sam helps most all taxpayers with the programs above. But there is also special help available for those with low to moderate income. You may not have heard of this one. It is called the Saver’s Credit. The Saver’s Credit may provide a credit (remember, credits reduce your taxes dollar for dollar) of up to $2,000 for a couple Married Filing Jointly or $1,000 for a Single filer or someone filing Head of Household. This credit is rather complicated, but here are some basics
- The maximum income limits (AGI) are as follows (this is the top limit and the phase out range is large)
- Married Filing Jointly: $57,500 in 2012; $56,500 in 2011
- Single: $28,750, in 2012; $28,250 in 2011
- Head of Household: $43,125 in 2012; $42,375 in 2011
- The maximum Credit is:
- $2,000 for Married Filing Jointly, if both spouses contributed $2,000 or more, each, to an IRA or TSP
- $1,000 for Single or Head of Household, if the contribution was $2,000 or more.
- Even if you qualify for the credit it could be as small as:
- $200 for Married Filing Jointly
- $100 for Single or Head of Household
- You can still claim this credit for 2011 if you contributed to TSP last year or if you contribute to an IRA before 17 Apr 12
- Complete IRS Form 8880 to see if you might qualify for the credit or to actually claim the credit on your 2011 return
It is hard to save money for retirement but it critical that you do. Your rich uncle understands that and his help is significant. Think of it this way. If you are single and contribute $2,000 to an IRA and are at the low end of the 15% bracket, Uncle Sam will potentially “pay for” $1,300 worth ($2,000 tax deduction = $300 and $1,000 tax credit) of your IRA contribution. $2,000 in the “bank” for a $700 net contribution. That is a pretty good deal!
Curt Sheldon is a Fee-Only Financial Planner based in Northern Virginia. He can be contacted at (703)542-4000, (800)928-1820 or Curt@CLSheldon.com
IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication
The information contained in this blog is for general financial education and should not be construed as individual financial advice. Please consult your own financial, tax or legal advisor prior to applying any principles discussed here to your own financial situation.