For people in the lower income tax brackets and recent graduates who may not have worked the full year, there is a Retirement Savings Contribution Credit (Saver’s Credit) that you can take advantage of. Most investment professionals tend to focus on people with higher incomes, therefore they may overlook this obscure tax credit. This little known tax credit can provide you a substantial return on your investment before any market returns. See the chart below applicable to 2015.
Depending on your filing status, you may receive up to 50% of your contribution as a tax credit. Suppose you are filing as a single person and made $18,250 in 2015 (doesn’t matter if you only started working later in the year, e.g. started your job in September so you only made ⅓ of your annual income). Your 2015 standard deduction is $6,300 and 2015 personal exemption is $4,000. You subtract your standard deduction and personal exemption from your income of $18,250 to get a taxable income of $7,950. Based on the table below from the US Tax Center, your federal tax rate is 10% or $795.
You can contribute $1,590 to your Roth IRA and receive 50% back in credit or $795. However, keep in mind that your credit is limited to the tax you owe. If you contribute $1700, you are still limited to $795 since that is the tax you owe. If you contribute less than $1,590, you’ll get 50% of the amount you contributed.
What Happens If I Make Slightly More than the Limit?
If you make slightly more than one of the Saver’s Credit income limits, you can contribute to a Traditional IRA to lower your taxable income. For example, if your adjusted gross income is $19,000, contributing $750 to your Traditional IRA will lower your taxable income by $750, down to $18,250. A Traditional IRA is a pre-tax retirement vehicle that will lower your tax obligations. After contributing to your Traditional IRA, you will then owe $795 in federal taxes, and you will also be able to receive 50% of both your Roth IRA and Traditional IRA contribution back as a Saver’s Credit.
Keep in mind however, the sum of your Traditional IRA and Roth IRA contributions may not exceed $5,500 for 2015.
Also, don't forget that there are other retirement vehicles out there besides IRAs. Check out my retirement vehicle map which will hopefully help you navigate the retirement landscape.
Please consult with your tax professional to maximize your retirement credit before making any tax decisions.
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