Double Dip for Retirement Savings

The tax law usually restricts the ability to benefit tax-wise from an expenditure to one tax break. This break may be an exclusion from income, a tax deduction, or a tax credit. However, there is one key exception to the general rule when it comes to retirement savings: You may be able to add to a savings plan, which gives you a deduction or exclusion (depending on the plan) and claim a tax credit, called the retirement saver’s credit, based on the same contribution amount. The IRS says that on 2009, over $1 billion was claimed in retirement saver’s credits on over 6.25 million returns.

Overview of double dipping

If you contribute to your company’s 401(k) or similar plan or you make contributions to an IRA, check to see if you also qualify for the retirement saver’s credit. The credit is 50%, 20%, or 10% of annual contributions up to $2,000. Thus, the maximum credit per taxpayer is $1,000 (50% of $2,000 contribution). Married couples can claim a total of $2,000 ($1,000 each) on a joint return.

Income limitations. The percentage for determining the credit depends on your modified adjusted gross income (MAGI). The 10% credit amount applies for those with MAGI as high as the following amounts:

• Married couples filing jointly with MAGI up to $56,500 in 2011 ($57,500 in 2012)
• Heads of household with MAGI up to $42,375 in 2011 ($43,125 in 2012)
• Married individuals filing separately and singles with MAGI up to $28,250 in 2011 ($28,750 in 2012)

Taxpayers who are not eligible. Even though you may meet the income limits, you are not eligible for the credit if you are:

• Under age 18
• Claimed as a dependent on someone else’s return
• A student (i.e., enrolled as a full-time student during any part of five calendar months during the year)

Distributions reduce the credit. Distributions from retirement plans reduce the contribution amount used to figure the credit. For 2011, this rule applies to distributions received after 2008 and before the due date, including extensions, of the 2011 return.

Savings on 2011 returns

It’s too late to make salary contributions to a 401(k), 403(b), or 457 plan for 2011. But it’s not too late to take advantage of this double tax break on your 2011 return, assuming your income permits it, using IRAs. You can contribute to an IRA for 2011 as late as April 17, 2012. However, you do not gain more time for making IRA contributions even though you obtain a filing extension.

Factoring in both the deduction for the contribution as well as the credit means that the government is really paying the lion’s share of the contribution. For example, say you are single, with MAGI of $18,100 (which puts you in the 15% tax bracket), and you add $2,000 to your IRA. Your tax savings from the contribution are $700 (15% of $2,000 + 20% of $2,000). Thus, your out-of-pocket cost for making the contribution is only $1,300 ($2,000 contribution – $700 tax savings).

Conclusion

The tax incentives for making retirement plan contributions can be a meaningful way to add to your retirement savings. Explore your eligibility to participate in your company’s retirement plan in 2012. Discuss your retirement savings and the tax breaks you are eligible for with your financial advisor.