Tax planning and compliance for investors
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Kaye A. Thomas
Updated January 6, 2008
Details on a credit some taxpayers can claim when they contribute to an IRA or 401k.
This topic is covered in Chapter 15 of our book, Go Roth!
People with low to moderate income find it hard to save for retirement, so there's a special tax credit designed to help this particular group. If you qualify, and you can scrape together the money for a retirement savings contribution, Uncle Sam will provide a credit that can be as much as half of the amount you contributed. If you're eligible, you can claim this credit even if you received matching contributions from your employer!
Example: You contribute $1,000 to your company's 401k plan and get a matching contribution of $500, so you have a total of $1,500 in your account. If you qualify for the highest level of this credit, you get a $500 reduction in your taxes, so it cost you only $500 to add $1,500 to your retirement savings.
Congress didn't want to allow this credit for minors, full-time students or dependents. You're disqualified if any of the following are true for the year you want to claim the credit:
In any of these situations you may be eligible to make retirement savings contributions, and it may be a good idea for you to do so, but you won't qualify for the credit.
* If you were born on January 1, you're considered 18 as of the day before your 18th birthday, on December 31 of the preceding year, for purposes of this rule.
There are income limits for this credit, depending on your
filing status. In the following chart, "MFJ" means married
filing jointly, and "HOH" means head of household. "Others" are
single, married filing separately, or qualifying widow or
widower. These are the numbers for 2008. Numbers for other years
are available in our Reference
|50% credit with income up to||$32,000||$24,000||$16,000|
|20% credit over that level, up to||$34,500||$25,875||$17,250|
|10% credit over that level, up to||$53,000||$39,750||$26,500|
For example, if you're married filing jointly with income of $40,000, your credit will be 10% of the amount contributed, up to the limit described below. But if your joint income is $30,000, the credit will be a whopping 50% of the amount contributed.
Income: For this purpose, we're talking about your adjusted gross income, which is your income after taking certain deductions (such as a deduction for your IRA contribution), but before claiming personal exemptions, itemized deductions or the standard deduction. If you excluded income from foreign sources, you'll have to add that back when figuring this credit.
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