The government offers tax breaks for people planning for retirement. You can reduce your tax liability to save money now while securing your future. The Internal Revenue Service allows you to deduct the annual amount you contribute to a qualifying individual retirement account. If you meet the income guidelines, you can combine the Saver's Credit with the contribution deduction to save you even more on your tax bill.
IRA Contribution Deduction
Traditional IRA contributions are tax deductible. A traditional IRA is an account funded with money that has not been taxed. The taxes are deferred until you begin taking withdrawals at age 59 1/2 or older. Your ability to deduct an IRA contribution is based on your tax-filing status, modified adjusted gross income (MAGI) and active participant status. You are classified as an active participant if you fund the IRA through an employer-sponsored plan. At the time of publication, nonactive participants are entitled to deduct the full contribution regardless of income or filing status. For single and head of household active participants, the MAGI determines the amount you can deduct. Single active participants with an income greater than $68,000 do not qualify for the deduction. For married couples filing joint returns, the deduction is phased out at $112,000 if you are both active participants. If only one spouse is an active participant, the couple can take the full deduction if the income is less than $173,000. A partial deduction is available if the couple's income is more than $173,000 but less than $183,000. No deduction is offered for an income greater than $183,000. Married couples who file separately are allowed only a partial deduction if the income is less than $10,000. An income greater than $10,000 does not qualify.
The Saver's Credit is a tax break for low- and moderate-income taxpayers who contribute to a retirement account. The nonrefundable credit can reduce your tax liability. If you do not owe taxes, the credit is not added to your refund. Your eligibility depends on your adjusted gross income and tax-filing status. You may be entitled to claim as much as 50 percent of the first $2,000 you contributed for the year. The maximum credit amount is $1,000 for an individual and $2,000 for couples who both made contributions. For 2012, the full credit is available to married couples who have an AGI of $34,500 or less. Single taxpayers can claim the full 50 percent credit if the income below $17,250. To claim the credit, you must be at least 18 years of age. You also cannot be a full-time student or claimed as a dependent.
If you meet the income requirements to deduct your IRA contributions and fall within the income guidelines for the Saver's Credit, you can take both on your tax return. If your income is too high for the Saver's Credit, deducting your IRA contributions may reduce your taxable income enough for you to qualify for the credit. The Saver's Credit is also offered for tax-deductible contributions made to other types of retirement savings plans, including a 401(k). The qualifying contributions for the retirement savings credit are reduced by distributions you received from your IRA. For example, if you contributed $1,200 to the IRA but received a $500 distribution during the year, the credit will be calculated on a contribution of $700.
If you have a Roth IRA, you cannot deduct your annual contributions. However, you can still claim the Saver's Credit if you meet the eligibility criteria. The Saver's Credit provides you a tax credit of up to $1,000 for your contributions, while your earnings grow tax-free. When you retire and begin taking withdrawals, the distributions are not reported as taxable income.
- IRS: 2012 IRA Contribution and Deduction Limits
- Turbo Tax: What Is The Savers Credit?
- Los Angeles Times: ss Retirement Saver's Credit Could Significantly Reduce Tax Bill
- IRS: 2012 IRA Contribution and Deduction Limits - Effect of Modified AGI on Deductible Contributions if You are NOT Covered by a Retirement Plan at Work
Jeannine Mancini, a Florida native, has been writing business and personal finance articles since 2003. Her articles have been published in the Florida Today and Orlando Sentinel. She earned a Bachelor of Science in Interdisciplinary Studies from the University of Central Florida.