Saver's Credit adds power to a smaller paycheck

On the Money

Your Money

February 04, 2007|By Gail Marksjarvis | Gail Marksjarvis,Chicago Tribune

Love that puny paycheck.

It may actually be small enough to help you save more.

You read that right. I did not say: "It may actually be large enough to help you save more."

Perhaps you struggle from month to month to pay the bills. Maybe you have had some calls from bill collectors, or overdraft charges on your checking account.

You may promise yourself that you will start saving for your future if you ever get ahead.

But the answer may be in front of you, in the tax return that's been beckoning for your attention.

I'm talking about the Credit for Retirement Savings Contributions, known as the Saver's Credit. It's a goodie found on your tax form but ignored by many tax professionals because most of their clients are too affluent to use it. Yet it can result in a refund for singles with incomes up to $25,000, married couples with incomes up to $50,000, and single parents that have incomes up to $37,500.

The maximum credit is $1,000 for individuals or $2,000 for couples, depending on your income and how much you save. But you have to put away money to qualify.

The result of using this savings device can be even better than it first appears. That's because of the way saving for retirement works on your taxes. Whether you put money into a 401(k) retirement savings plan at work or an individual retirement account, known as an IRA, outside of work, your savings will cut the income that Uncle Sam taxes.

That snowballs through your tax return, turning small credits for children or low-income individuals into bigger credits. And in the end it can make your refund larger than you ever imagined.

Of course, all of this depends on your income level and details such as whether you have children and how many.

To understand the possibilities, consider Sabrina, a Nashville, Tenn., mother of three who has been getting financial advice from financial planner Keith Newcomb of Full Life Financial in Nashville.

When Sabrina sought help about a year ago, she was drowning. With an income of $30,000, she wasn't saving anything and was running up almost $4,000 a year in charges for late payments on bills and overdraft charges, Newcomb said.

He helped her plan better so this would not happen. But this year he figures she could get significant help with a smarter approach to the tax system.

By putting $4,000 into a 401(k) retirement savings plan at work, Sabrina could save for retirement and end up with the government paying for it, Newcomb said.

Uncle Sam wants people to save for their future and provides rewards to those who do it. Low-income people receive extra help.

In a nutshell, here's how it works: By putting $4,000 away for retirement, Sabrina slices away $4,000 from her income. So instead of seeing her as having $30,000 in income, Uncle Sam sees only $26,000.

That makes it look as if Sabrina's household faces a greater financial challenge than it otherwise would. As a result, the government sees a bigger need to help Sabrina's family: With a lower income, she is entitled to larger tax credits.

With a $30,000 income, she would have been given an earned income tax credit of about $1,750. This is a credit available to people with low incomes. But because her savings lowered her income to $26,000, she gets a larger credit - about $2,600, Newcomb said. Also, because her income is lower, she qualifies for an additional tax credit for her children - $1,670 instead of about $1,070.

The bottom line is that Sabrina's refund becomes about $1,400 more than she would have received without the fancy tax work, according to Newcomb's calculations.

Contact Gail MarksJarvis at gmarksjarvis@tribune.com or leave a message at 312-222-4264.

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