Low and middle income tax payers can benefit from creating and/or contributing to an Individual Retirement Account. I know it doesn’t sound exciting. Many people understand the benefits of an IRA and being able to lower taxable income, but this credit is better than the IRAs standard benefits (which is an excellent benefit for virtually all income levels).
A tax credit is better than a deduction. While a deduction lowers your taxable income, a credit directly reduces your taxes. But if make less than $65,000 (married filing jointly) the Saver’s credit allows you to take a deduction and a credit! To illustrate, let’s take an example of the Johnson family. Jill makes $38,500 a year, while her husband Bob is currently unemployed. Jill makes a contribution to a new IRA of $2000. This will qualify the Johnson’s for $1000 tax credit…so if they had any taxes to pay, this amount would be reduced by $1,000. So, not only has Jill saved for retirement, she is able to save $1,000 on her tax return. She can double these savings by making a spousal contribution to Bob’s IRA. So they could save up to two thousand dollars on their taxes and have $4,000 invested in an IRA that can grow and help build a nest egg for retirement.
You can determine how much your credit will save you through the worksheet on IRS form 8880 which can be found here. This Saver’s credit decreases depending as your AGI goes up. However, you have to remember that Traditional IRAs can save you money on your tax return for any income level because every dollar contribution directly reduces you taxable income for the year. If you participate in other retirement plans there are limits to deductible contributions. I’d be happy to talk with you about what savings you would get by contributing to an IRA. Of course, one of the primary benefits of an IRA is that funds invested in an IRA can grow tax-deferred until it is withdrawn. This allows investments to grow according to the magic of compounding without the effects of yearly taxation on realized capital gains, dividends, or interest payments. Instead, all these types of income can be reinvested within this tax-free account. This can make a big difference over many years.