Can The IRS Help You Save For Retirement?
October 20, 2014Saving for retirement is a must these days and retirement confidence in general is pretty low. Our recent retirement preparedness study revealed that only about 20% of employees feel they’re on track to reach their desired income in retirement. In order to bridge this gap, it’s no secret many of us need to save more. 
A general guideline many financial planners use is to strive to save at least 10 to 15 percent of pay toward retirement. However, contributing to a retirement plan at work or through an individual retirement account can become a significant challenge if you are on a tight budget or burdened by debt obligations. In these situations, it may appear that every dime is needed for current living expenses.
During a recent retirement planning consultation, a single mother expressed her desire to me to take control of her financial future. After living paycheck to paycheck for a couple of years, she was excited to report she had just eliminated her credit card debt and built a starter emergency fund. We discussed the importance of increasing her 401(k) contributions so she could receive the full matching contribution from her employer. This was a no-brainer with a 100% matching contribution that was fully vested immediately.
The problem was that she was only able to currently increase her contribution rate from 2% to 3% (her employer’s plan matched the first 6%). After explaining an easy and effective strategy called the contribution rate escalator feature, we created an action plan to gradually increase her contributions 1% every year until she reached a 15% contribution rate. It may take some time to get there but these gradual changes will have a significant impact over time as this calculator demonstrates.
The IRS contribution limit of $17,500 can seem like a lofty goal for most Americans and was certainly not an option for determined employees like the committed saver that I was working with. The good news is that she and many other workers may be eligible for an additional boost to their savings: a tax credit. The tax credit is called the Retirement Savings Contribution credit.
There are income limitations to be eligible for the credit, and a calculation is done based on the taxpayer’s income level to see how much is actually available, but the end result is a tax credit. The tax credit can be as high as $2,000 per person! Remember that a tax credit is subtracted directly from the taxes owed at the end of the year, whereas a deduction decreases your taxable income (before the taxes are calculated).
The amount of Retirement Savings Contribution Credit is 50%, 20% or 10% of your retirement plan or IRA contributions up to $2,000 ($4,000 if married filing jointly), depending on your adjusted gross income (reported on your Form 1040 or 1040A). In 2014, the credit is available for married couples filing jointly with adjusted gross income (AGI) under $60,000 and single filers with income below $30,000. Head of household filing status can use the credit as long as the AGI is below $45,000.
Not sure how much of an impact saving a little extra in a retirement plan through work or an individual retirement account will have on your ability to retire? You can use this basic retirement estimator to get a quick snapshot of ways to get that retirement plan on track: https://ffcalcs.com/retirement_estimator. For more information on whether or not you or someone you know qualifies for the Retirement Savings Contribution Credit, check out the following link from the IRS: http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-Retirement-Savings-Contributions-Credit-(Saver%E2%80%99s-Credit)
It is hard to believe that October has already arrived. Tax returns will be due again before we know it. Don’t wait to start taking some important steps to reduce your income taxes and ramp up your retirement savings.