Retirement Savings Contribution Credit
The Retirement Savings Contribution can reward workers who make contributions to a retirement plan or Individual Retirement Account(IRA). Workers can receive a tax credit worth up to 50 percent of a maximum $2,000 contribution. Married workers may each make the maximum contribution. The Retirement is referred to in IRS tax forms as the “Credit for Qualified Retirement Savings Contributions.” This may be particularly valuable for workers in areas where matched-savings plans, such as Individual Development (IDAs), are not available or when saving for retirement is a higher priority for a family than the uses that may qualify for matched savings in an IDA.
The Retirement Savings Contribution Credit will reduce or eliminate a worker’s income tax but, unlike the Earned Income Tax Credit, workers who owe no income tax will not benefit from the Saver’s Tax Credit. However, some moderate-income worker’s with children may see increased benefits from the EITC when they make contributions to a retirement account through pre-tax salary deductions and take advantage of the Saver’s Tax Credit.
Here’s why:
• Generally, only taxable earned income is counted in figuring the EITC. Most EITC claimants who make contributions for retirement through pre-tax salary deductions are in the “phase-down” range of the EITC, where EITC amounts decrease as taxable income increases. Since the salary deductions made for retirement reduce the worker’s taxable income, the worker will qualify for a larger EITC.
Example: Randy and Meg earned $25,000 in 2006 and have two children attending college. They ordinarily would owe income tax of $150 and would qualify for an EITC of $2,811. However, during the 2006 they made contributions of $1,000 to Meg’s retirement plan at work through pre-tax salary deductions. This reduces their taxable income to $24,000, and reduces their income tax to $50, a $100 savings. Since only their $24,000 in taxable earnings is considered in calculating the EITC, they will qualify for a higher EITC of $3,022, an increase of $211. And, they can take the Retirement Savings Contribution Credit (in their case worth up to 50 percent of their $1,000 contribution – as much as $500 in reduced income tax),which eliminates their $50 income tax. Overall, by making the $1,000 contribution to Meg’s retirement account and taking the Retirement Savings Contribution Credit, the couple gets a tax benefit of $361. (Their original income tax amount was reduced by $100 and then the remaining $50 was eliminated, for a total tax reduction of $150. In addition, by reducing their taxable income, they were able to claim an EITC that was $211 higher than it would have been had they not made the retirement plan contribution: $150 + $211 = $361.
• Also, since the Retirement Savings Contribution Credit reduces or eliminates the income tax a worker may owe, if the worker also qualifies for the Child Tax Credit, less of the CTC will need to go toward reducing income liability and more will be available for a refund to the worker.
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