When you think about retirement, are you stuck in disillusionment somewhere between your dreams and the reality of an empty retirement account? Perhaps this is because you are currently (and have been) living paycheck to paycheck and any extra savings you squeeze out of the month goes towards putting out last month’s fires. All of the financial gurus (and me!) say to start saving no matter what, but the prospect seems overwhelming when you are worrying about more present-day concerns like variable electricity bills and car repairs.
If this describes you, then I’ve got an idea I’d like you to entertain. Yes, it involves you putting money into a retirement account, just like what all of the other retirement articles out there tell you to do (obviously a very sound strategy to retirement savings). But please keep reading, as this information and strategy has the potential to help you fund a retirement without dipping into your monthly paycheck.
Tax Benefit Number 1
Certain taxpayers who meet income limits/filing statuses, and who contribute to a retirement account are eligible for a tax credit called the Saver’s Tax Credit. The limits are:
- Single, married filing separately, or qualifying widow(er) with income up to $29,500
- Head of Household with income up to $44,250
- Married Filing Jointly, with incomes up to $59,000
Depending upon your income, you will be given a credit of up to $1,000 for Single, or up to $2,000 for Filing Jointly. The amount is a percentage of any contributions you have made to qualifying retirement accounts such as an IRA, 401(K), and certain other retirement plans. What a great deal!
Tax Benefit Number 2
On top of a tax credit for funding your retirement account, you can score a tax deduction (without having to itemize deductions). Traditional IRA contributions are made based off of post-tax dollars. This means that at the end of the year contributions are typically tax deductible. You will receive the Saver’s Tax Credit on top of the tax deduction you can all ready take on contributions to a traditional retirement account. That is a tax deduction and a tax credit for the same money. And let’s not forget that this money is going towards your own financial future. Again, what a great deal!
How to Take Advantage of These Tax Benefits if You Have No Money
At this point you might be excited, but wondering how on earth you are going to take advantage of this. Every year tax refunds and ideas for how to spend them are splattered all over the media—commercials from companies hoping you’ll buy that new appliance and news/media trying to determine how much of a stimulus this refund season will be for the economy. The refund is glamorized, with American taxpayers gleefully skipping down the path of the rainbow towards their new found gold. In fact, some Americans pay no federal income tax and still receive a tax refund.
According to the Tax Policy Center, in 2011 46.5% of American households will pay no federal income tax. Not only will such a large percentage of American households not owe any federal income tax, but some of these households will receive a tax refund. This is due to the Earned Income Credit (EIC). To give you an example, here is a quote from IRS Notice 797:
“If eligible, you can claim the EIC to get a refund even if you have no tax withheld from your pay or owe no tax. For example, if you had no tax withheld in 2011 and owe no tax but are eligible for a credit of $829, you must file a 2011 income tax return to get the $829 refund.”
Call me crazy, but with so much advertising and media coverage of this joyful time in the U.S., I have a hunch that most people are not saving their tax refund; they are spending it. For families living paycheck to paycheck, this probably does feel a little like winning the lottery and I am sure you have some pent-up consumer demand for things that you could not afford over the last year (maybe a washer broke, the car needs a repair, extracurricular activities for your child, medical needs, etc.). In this case a tax refund actually fits well into your budget plan for the year. But what if you harness your tax refund instead? Doing so could reap you two tax benefits unavailable to others, as well as lead you on the path to a retirement more comfortable than your present circumstances.
Now, Roll Your Double Tax Benefits to Maximize Retirement Savings
To do this for one year is great. But what if you take part of your tax return every year and make a retirement account contribution? Your retirement savings would continue to grow, funded in large part by tax benefits. You could start this year by investing part or all of your refund, reaping you a larger tax return for next year. Next year, you can take that tax refund and contribute to retirement, reaping you a larger tax return for the following year. Do you see a nice pattern forming? So long as you meet the requirements, you could essentially roll the tax benefits and contribute to your retirement every year.
The money is technically not coming out of your monthly pay (though I say this with caution because you could adjust withholdings and have more money in your paycheck each month and less of a refund each year). And while you will be investing in one lump sum (and not dollar cost averaging), not saving for retirement at all is a much greater risk than short-term market volatility.