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Tax Planning for the Retirement Savings Contribution Credit

A reader writes in, asking:

“Based on my gross income, I don’t quite qualify for the retirement savings credit. But I’m not maxing out my 401k. If I contributed more to the 401k would it reduce my income so that I *would* qualify for the credit?”

In short, yes, it could.

How the Retirement Savings Contribution Credit Works

For those unfamiliar with the Retirement Savings Contribution Credit, it’s calculated as a percentage (either 10%, 20%, or 50%) of the first $2,000 of contributions you make to a retirement account per year. (If married filing jointly, the first $2,000 of contributions for each spouse can be counted.) As your adjusted gross income increases, however, the percentage used to calculate the credit decreases. The income ranges for 2013 are as follows:

Married filing jointly:

  • Up to $35,500: credit = 50% of contribution
  • $35,501-$38,500: credit = 20% of contribution
  • $38,501-$59,000: credit = 10% of contribution
  • Above $59,000: Not eligible for credit

Single:

  • Up to $17,750: credit = 50% of contribution
  • $17,751-$19,250: credit = 20% of contribution
  • $19,251-$29,500: credit = 10% of contribution
  • Above $29,500: Not eligible for credit

Head of household

  • Up to $26,625: credit = 50% of contribution
  • $26,626-$28,875: credit = 20% of contribution
  • $28,876-$44,250: credit = 10% of contribution
  • Above $44,251: Not eligible for credit

Taking Control of Your Adjusted Gross Income (AGI)

The key point from a planning perspective is that the credit is based on your adjusted gross income (that is, the bottom line from the first page of your Form 1040), which you have some degree of control over. As the reader surmised above, pre-tax contributions to a 401(k) would reduce this figure, as would deductible traditional IRA contributions and HSA contributions. In fact, any of the deductions listed on lines 23-35 of Form 1040 reduce your adjusted gross income, though retirement plan contributions and HSA contributions are typically the ones over which you have most control.

So, if your AGI is anywhere just above one of the applicable threshold points, taking action to reduce your AGI such that it falls below the threshold in question could increase the amount of your credit — either by making you eligible when you otherwise wouldn’t be or, for example, by moving your income to the range where the credit is calculated as 20% of your eligible contributions rather than 10%.

For more information about the credit (such as the requirements to claim the credit other than having an adjusted gross income below the applicable threshold levels), see Form 8880 and its instructions or IRC Section 25B.

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