Sunday, March 11, 2012

Retirment Savings Tax Credit

In addition to getting a deduction on your taxes, your IRA contribution may qualify you for an outright tax credit.  Sweet!

In doing my taxes this year, I noticed this tax credit on TurboTax.  It is worthwhile looking into, even if you don't think you qualify.  Bear in mind that the credit is available for those with a taxable income of $27,750 or less, not a gross income of that amount.   By the time you get done with your deductions, even an income of $50,000 or more can end up less than this.

And of course, the more you contribute to your IRA or 401(k), the lower your taxable income is.    Putting a few hundred dollars more into your IRA could end up reducing your effective income to the point where you qualify for enough tax credit to offset the cost of the additional contribution.  If you are making the median income in this country, this tax credit is worth exploring.  If you are using TurboTax, be sure to click on the link, as it may not calculate the tax credit for you automatically.

Is this tax credit fair?  Yes, yes it is and let me tell you why.   As I noted in another posting, our progressive tax system taxes people with higher incomes at higher marginal rates.  But, this also means that people who make a lot of money also make a lot more money on tax deductions.   So a home mortgage interest deduction is higher for someone in the 25% bracket than it is for someone in the 15% bracket.   The same house costs less to own, for richer people, as a result.

And ditto for IRA and 401(k) contributions.  To the guy in the  25% bracket, $100 in his IRA costs him $75.  to the guy in the 15% bracket, it costs $85.  And that just ain't right, is it?  After all, who needs more money in his 401(k) down the road?  The guy in the lower bracket.

Are there catches?  Yes, you must be 18 or over, and for some reason, full-time students are not allowed this credit.  Presumably, this is to prevent parents from setting up an IRA for their kids and then claiming the tax credit, as the "student" has no appreciable income.  Wow, I could think of a lot worse things in the world than incentivizing parents to start a retirement savings plan for their kids when they are 18.  Rather than discouraging this, we should double-down our bet.

But that's just me.

Tax CREDITS are the sweet, juicy low-hanging fruit on the tree, and you should take them whenever possible.  This is cash-to-you, directly from your Uncle Sugar, as opposed to merely reducing your income, for taxation calculation purposes.

For more information on the difference between tax credits and tax deductions, see: