Tip on Retirement Savers Credit: The Difference Between an AGI of $15,000.50 and $15,000.51
The Retirement Savers Credit can be claimed using form 8880. Depending on one's marital situation and income (no-more than $50k), one may be able to obtain the savers credit. This credit can reduce the taxes the State will steal from you to $0, but it cannot get you a subsidy (State-payout). It can be used whether or not you itemize your 1040 or 1040A, but cannot be used with a 1040EZ. However, there are a few snags to think about when planning ahead. Before explaining them, let me briefly over-view what is required to be able to claim the credit:
- Adjusted Gross Income must be less than:
- $25k if single
- $50k if married, filing jointly
- $37.5k if head of household
- Must have made contributions to a qualified retirement plan, such as a Traditional IRA, Roth IRA, 401(k), 403(b), etc.
- Cannot be claimed as a dependant on someone elses' tax-returns.
- Cannot be younger than 18.
- Cannot be a full-time student.
The way the tax-credit works is that you get a credit for a fraction of the lower of either your contributions to retirements savings plans or $2,000. What fraction is multiplied by $2,000 or your retirement-contributions (whichever is lower) is determined by your income and filing-status. Here's a table summarizing it:
Credit rate Adjusted GrossIncome Limit Maximum Credit Single; widow(er); married, filing separate Married, filing jointly Head of household 50% AGI ≤ $15,000 AGI ≤ $30,000 AGI ≤ $22,500 $1,000 20% $15,000 < AGI ≤ $16,250 $30,000 < AGI ≤ $32,500 $22,500 < AGI ≤ $24,375 $400 10% $16,250 < AGI ≤ $25,000 $32,500 < AGI ≤ $50,000 $24,375 < AGI ≤ $37,500 $100 0% AGI > $25,000 AGI >$50,000 AGI > $37,500 $0
Many of you probably already see what I'm about to talk about. If you're single and your Adjusted Gross Income is $15,000.49, you can get a maximum of an $1,000 credit; this is because you're allowed to round on your 1040 or 1040A, so it rounds down to $15,000 (the choice to round or not round has to be for all fields). However, if you're single and your Adjusted Gross Income is $15,000.50, your maximum credit is $400: A 600 dollar difference for one extra cent! (This is something I find extremely idiotic). It is highly unlikely that many will be that close to the margin; however, it is entirely within the realm of probability that there will be many $10, $20, $50 away from the difference between a $1,000 credit and a $400 credit.
One way to get around this grave annoyance would be to see if you can lower your AGI. Tax-deferred contributions to a Traditional IRA, 401(k), 403(b), etc would be one way to do that. A common strategy for the forward-oriented is to max-out contributions to a 401(k)/403(b) and max out contributions to a Roth IRA (the contributions of which are not tax-deductible, but grow tax-free not tax-deferred). Currently, the maximum that one can contribute to a Roth and Traditional IRA together is $4,000. This means that money contributed to a Roth IRA reduces the possible money one can contribute to a Traditional IRA. Thus, for someone on the margins of a percentage-break in this tax-credit, it may be adviseable to consider diverting the minimum amount of Roth IRA contributions to a Traditional IRA so as to set one up (see this thread on BenefitsLink for a discussion of the minimum required startup amounts for IRAs). Thereafter, you can contribute solely to your Roth IRA; if you foresaw falling on the margins of a break-point again, you could divert the minimum amount from you Roth IRA (which does not lower AGI) to your Traditional IRA (which does lower AGI) so as to make the breakpoint.
This obviously makes tax-deferred retirement contributions more valuable, ceteris paribus; thus, you may have to re-evaluate the desireability of Roth IRAs vs. Traditional IRAs, if you are at the margins of the saver's credit breakpoints, or within $4,000 dollars of being at a breakpoint. Consider, for example, if you're single and your income is $33,000. Maxing out 401(k) or 403(b) contributions would provide a downward adjustment of $14,000 (AGI would thus be $19,000). You now have $4,000 dollars to contribute to a Roth IRA or Traditional IRA. An $4,000 contribution to a Traditional IRA would reduce your AGI to $15,000, while a $4,000 contribution to a Roth IRA would not change your AGI. You now have to decide if the benefits of the Roth IRA's tax-free growth are worth (to you) the costs of a $4,000 tax-deduction (which lowers your taxes by a fraction of $4,000, depending on your tax-rate) and a $1,000 tax-credit. I say to you, because the subjective costs may be different to two different people in the exact same situation, because of differing time-preferences. The more you value that $1,000 tax-credit and $4,000 deducitlbe now, the less the subjective benefits of tax-free growth (which will be reaped in retirement) will be. The shorter your time-horizon on your retirement funds, the more attractive the benefits of this course of action, as well. How well you expect your investments to perform, and whether you expect taxes to go up or down (the safe bet's on the former) also play into the decision, along with your current effective tax-rate and your expected future effective tax-rate.
Moving away from that example, the other thing you have to decide is if figuring out all of this stuff is worth it to you ex-ante: That is, do your expected subjective costs of doing such exceed your expected subjective benefits. Put another way, the work of all this may be worth it to many people to save $1,000; but it probably won't be worth it to anybody -- except someone with an extreme neurosis -- to save $1.
Recharacterization: Up until Apri 15th, you can still recharacterize Roth IRA contributions for the prior year (the year for which you're paying taxes) to Traditional IRA contributions. If doing this and opening up a new Traditional IRA with that company, you'll have to recharacterize the minimum to open up a Traditional IRA (varies from company to company, but again see my prior ref to a BenefitsLink thread). Thereafter, to engage in this kind of strategy, you'll only have to recharacterize the precise amount that you need (or the nearest rounded up amount thereof that your financial institution will allow you to recharacterize) in order to get your AGI down to a Retirement Savers Credit breakpoint. It is probably most wise to figure out what you need to recharacterize (if anything) after the year for which you're paying taxes ends, so that you don't recharacterize anything more than you need to in order to get the credit.