Simple Retirement Savings Strategies with Unusual Tax Benefits

Minter Jeffrey asks:

“I work, my wife doesn’t. She takes care of our daughter and may someday go back to work so right now I’m contributing half my retirement savings into an employer 401k and the other half into my employers Roth 401k.

By delving into my tax documents from last year, I realized that I could have doubled my Retirement Savings Contribution Tax Credit ($200 to $400) if my wife and I both had retirement accounts, rather than everything being in my name. Could I take the money that would have gone into a Roth 401k and put into a Spousal IRA?”

Before I answer Jeffrey’s question, a mea culpa. I wrote back to Jeffrey immediately—with the wrong answer. I told him, no, it can’t possibly be that easy to collect an extra $200 from Uncle Sam.

But Jeffrey was right, and by making a simple change to his retirement saving strategy, he’ll get an extra $200 back on his taxes next year.

Spousal savings

To understand how Jeffrey’s family is going to collect an extra two hundo, we need to delve into two areas of the tax code you may not be familiar with.

You probably already know about the IRA and Roth IRA.

If you qualify (it’s based on your income and whether you participate in a 401(k) at work), you can contribute up to $5500 per year of earned income to an IRA and get a big tax break. (You can toss in an extra $1000 if you’re 50 or older.)

“Earned income” means the money you put into your IRA has to come from a paycheck of some kind. It can’t come from a gift or investment earnings.

The exception to this rule is the Spousal IRA. If you work and your spouse doesn’t, you can contribute another $5500 (or $6500 for age 50+) to your spouse’s IRA.

That’s the first piece of the puzzle. Read on.

Get paid to save

Next up, the Retirement Savings Contributions Credit, also known as the Savers Credit.

The Savers Credit is a strange beast. It’s designed to encourage Americans to save for retirement by offering savers the only kind of love the IRS understands: cash.

Of course, no one wants to give tax breaks to wealthy people who were going to save anyway. So the Savers Credit is only available to those with lower to middle incomes.

The most generous version of the credit is for families making less than $34,500 (married filing jointly) or $17,250 (single).

And the credit disappears completely if you make more than $57,500 (MFJ) or $34,500 (single).

Furthermore, the Savers Credit is nonrefundable: it can’t reduce your federal tax bill below zero.

And many people who would have qualified for the credit can’t claim it because they pay no federal income tax to begin with.

Jeffrey, however, finds himself in the sweet spot: his household income is under $57,500, and this year he got $200 for contributing over $2000 to his 401(k).

Adding it up

To get back to the original question (finally!)…

If Jeffrey takes $2000 that he was going to contribute to his own 401(k) and puts it into his wife’s Spousal IRA instead, his wife is now also eligible for the Savers Credit.

In other words:

Jeffrey’s 401(k)	Wife’s spousal IRA	Total credit
$4000	0	$200
$2000	$2000	$400

 

Of course, if Jeffrey and his wife make some extra money this year and their adjusted gross income (AGI) goes even a dollar over $57,500, they become ineligible for the credit.

However, if necessary, they can reduce their AGI to qualify for the credit by contributing more money to Jeffrey’s 401(k) or his wife’s traditional Spousal IRA.

I learned this trick from a post last week on Mike Piper’s Oblivious Investor blog.

The take-home

Finally, I advised Jeffrey and his wife to open that Spousal IRA at a low-cost mutual fund provider like Fidelity, Vanguard, or Schwab.

There are two take-home messages here:

1. Be on the lookout for unusual tax credits.

2. Be skeptical of off-the-cuff advice from your local finance columnist.