2 tax-friendly methods for boosting retirement savings

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Catch-up contributions and the saver’s credit are two tax-friendly methods that help some clients boost their retirement savings.

The IRS allows workers 50 and older to make deductible contributions above regular limits to retirement plans. For 401(k)s, the additional allowed amount is $6,000.

The extra savings can have a significant impact for some clients over time, says Suzanne Shier, chief tax strategist at Northern Trust in Chicago.

Suppose a 50-year-old client has $200,000 in a 401(k), she says.

“If they go from contributing $18,000 to $24,000 a year and they do that for 15 years and we assume a 6% pretax return, at age 65 they’re going to have more than $1 million in that 401(k),” Shier says.

Similarly, workers over 50 can put an additional annual $1,000 into individual retirement accounts, bringing the total to $6,500 a year.

The IRS also allows a retirement savings contribution credit, known as the saver’s credit.

Married couples filing jointly with an adjusted gross income of less than $37,000 are eligible for a 50% tax credit of up to $2,000 for the first $4,000 contributed to a 401(k) or IRA. For a single filer, the maximum credit would be $1,000 for the first $2,000 contributed.

Because it is a tax credit, it offers a benefit in addition to the tax-deferral of a 401(k) or IRA contribution.

Unlike deductions or retirement plan contributions, which reduce the amount of income subject to tax, tax credits reduce dollar-for-dollar the amount of tax owed, says Shier’s colleague, Benjamin Lavin, a wealth planner and associate tax strategist at Northern Trust.

On the other hand, the saver’s credit is non-refundable, so that if the credit is greater than the tax owed, the taxpayer won’t get any of it back, Lavin says.

The percentage credit is reduced from 50% to 20% to 10% as income increases, and isn’t allowed for married couples filing jointly who have AGI of $61,500 or more.

The credit is especially useful for many moderate- and low-income workers who aren’t in a position to itemize deductions, Shier says.

“So the credits are really helpful for them,” she says.

And even though very few people whose incomes are low enough to qualify for the saver’s credit are working with advisers, Shier points out two ways in which they can be important adviser tools.

“A client might have a child they are passing this information on to,” she says.

And the saver’s credit can help younger people learn the benefits of saving early.

“It helps them to understand that they could be paying themselves instead of paying the government,” Shier says. “That’s what the adviser wants to be communicating: You can pay $750 in taxes, or you’re going to be able to put $1,500 into savings, and it’s only costing you $750 to do that.”

This story is part of a 30-30 series on preparing for retirement.

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