Save $1,000 on Your Tax Bill

If you qualify, the Savers Credit can cut your payment to Uncle Sam by a lot.

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You might think that the biggest gift from the government when it comes to taxes is the mortgage interest deduction, but there is something better. The Retirement Savings Contribution Credit—or Savers Credit—is often overlooked, but it reduce the tax bill by up to $1,000 for millions of American taxpayers.

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It's quite simple. To get the full credit, invest at least $2,000 across your retirement accounts including your 401(k), Traditional IRA, and Roth IRA. Even if you don't or can't contribute that much to your retirement fund, you can still qualify for a credit of less than $1,000. You have until April 18 or your extended deadline to contribute to your Traditional or Roth IRA, so there is still time left right now to qualify for this tax credit.

There is a catch preventing taxpayers from qualifying. This is a credit for lower-income households, so there is a limit to the amount of income you can earn. The government designed this credit as an incentive for taxpayers to contribute to their own retirement. Taxpayers filing single, married filing separately, or qualifying widow(er)s cannot have an income exceeding $27,750 for 2010. For married filing jointly, the income maximum is $55,500.

I'll be honest. When I was working for a non-profit agency right out of college, earning not much more than that $27,750 limit, being able to save for retirement was a concept that didn't even cross my mind. This is an income level at which, for those living in some locations, it’s common for people to live paycheck-to-paycheck, barely meeting their expenses. These families could using every penny of their income for the necessities of life that allow them to wake up the next morning and work for another day. Financial writers often look at this credit and think families are crazy for not taking advantage of the incentive, and they don't realize that saving for retirement can be difficult for those families that this tax credit is designed to help.

Even though it can be difficult to qualify, there are two reasons I love this tax credit.

1. The credit is free money. Look at it this way—you are investing $2,000 for your future, $38.50 a week, and it's only costing $19.25 a week. You can't buy a $2,000 television for $1,000. There is no "New Cell Phone Buyers Credit." If there is any way to make retirement saving on your income possible, consider taking advantage of at least a portion of this credit.

2. The Savers Credit is not a deduction. A $1,000 deduction would only reduce your tax bill by $250 if you were in the 25 percent marginal tax bracket. A credit reduces your bill by the full amount of the credit. The Savers Credit is much more valuable than a tax deduction of the same amount.

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There are some drawbacks to the Savers Credit. Unfortunately, the credit is nonrefundable. If you owe less to the government than the amount of your credit, you will not get a refund. This credit can reduce your tax bill to zero, but won’t go further to the point where the IRS owes you money. Furthermore, the total credit you can qualify for begins to decrease at a fairly low income level, reducing fully to zero for income levels that meet the maximums listed above.

Even with these drawbacks, millions of taxpayers can qualify for a credit they might not know about. It’s common to complete income tax forms online now, and tax software applications usually complete the calculations behind the scenes. Many taxpayers who receive the Savers Credit may not know that it is in effect, particularly because it’s not publicized well. With this knowledge, however, now would be a great time to begin contributing to your retirement accounts for this year, so when April 2012 comes around you’ll qualify without having to think about it.

Luke Landes writes for Consumerism Commentary, where he encourages discussions about money and consumer issues. Consumerism Commentary regularly tracks and reviews the best credit cards and other financial products.