Tax Breaks For Lower Income Individuals
Our last posting covered tax-saving strategies for the charitably inclined. This week we will cover some tax breaks available to lower-income individuals to assist them in saving for retirement.
The federal income tax deduction for IRA contributions dates back to the early 1980’s and it has undergone several rule changes since its inception. For wage earners who are not covered by a retirement plan at work, tax deductions (taken as an adjustment to income on Schedule 1) are always available, up to the full annual contribution limit. For single taxpayers in 2020 who are covered by retirement plans at work, modified adjusted gross incomes* (MAGI) below $65,000 make them fully eligible for this adjustment to income, while MAGI’s in the range of $65,000 to $75,000 permit a partial, prorated deduction. Single filers with MAGI’s above $75,000 are still eligible to make their full IRA contribution, however, they are ineligible for an income tax deduction on the amount contributed. Taxpayers in this last circumstance should make sure to file Form 8606 with their tax return to prevent an eventual “double-taxation” on their contributed amounts.
If the filing status is married filing jointly, the respective phase out range is $104,000-$124,000**. For all taxpayers with sufficient earned income, IRA contributions for 2020 can be as much as $6,000. Contributors older than age 50 are permitted to add an additional $1,000 as a “catch-up contribution”. A common misconception is that non-working spouses cannot contribute to their IRA’s. In reality, both spouses are permitted to make contributions, provided at least one of the spouses has earned income equal to or greater than the combined contributions of both individuals.
Many taxpayers fail to take advantage of the tax reduction opportunities cited above. However, our next topic is even less utilized. Congress introduced the Saver’s Tax Credit as an inducement for lower-income households to save for their retirements. In essence, the tax code is subsidizing the contributions for these individuals by providing a tax credit for those people who make them. The subsidy could vary from 10% up to 50% of the amount contributed depending on filing status and income. Keep in mind that tax credits are more desirable than deductions because tax credits offset tax liabilities on a dollar-for-dollar basis. The Saver’s Tax Credit is claimed on Form 8880 entitled Credit for Qualified Retirement Savings Contributions. The eligibility requirements for the Saver’s Tax Credit are outlined in IRS Publication 590A and contributions to both IRA’s and employer sponsored plans like 401k’s, 403b’s and SIMPLE IRA’s will qualify. The Congressional Budget Office notes that millions of dollars of this possible credit go unclaimed every year.
If you would like to learn more about these and other wise financial planning moves, please contact us through our Level 5 Financial LLC website or via phone at 719-323-1240. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.
*See IRS Publication 590A for the exact definition of modified Adjusted Gross Income.
** See IRS Publication 590A for special income limits for the situation where one spouse is covered by a retirement plan at work, while the other spouse is not.