Low-wage savers can get free cash from Uncle Sam

You might be able to turn your 2010 job problems into a nice sum of money from Uncle Sam at tax time, especially if you’ve been lucky enough to find a job after being unemployed.

When you sit down to do your taxes, pay attention to what’s called the Saver’s Tax Credit or the Saver’s Credit. It’s a little-known freebie offered by Uncle Sam, a reward of up to $1,000 for your future.

Few people know about it, because it’s for people with low incomes. So financial advisers, who tend to have affluent clients, aren’t familiar with it, and the rules make it hard to qualify when struggling paycheck to paycheck.

But that’s where you might be able to turn last year’s bad fortune into good fortune now.

If you were out of work last year, your income was probably low. And if you now have a job, you might just have a little extra cash to stick into an individual retirement account, or IRA. If you do that, the Saver’s Credit could be yours, and you will be on your way to accumulating money you will need later.

To be eligible, married couples’ adjusted gross income can’t exceed $55,500, and the cutoff for singles is $27,750. For the maximum credit, which is 50 percent of money saved for retirement in an IRA or 401(k)-type plan up to $2,000, married people can’t have incomes of more than $33,500; singles, $16,750.

Even if cash is tight, however, opening an IRA could be a lot more affordable than some people realize. Low-income workers can sometimes use a tandem of tax credits, including the Saver’s Credit, to boost their tax refund and generate the money to save.

Bloomington, Minn., financial planner Ed Schrotenboer found this to be the case with a 32-year-old mother of two, who earned about $20,000 on a job last year and about $10,100 in unemployment compensation.

By putting $500 into an IRA, she was able to lower her income enough so she ended up owing no taxes, thanks to some important tax credits. Among them: the Earned Income and Child Tax credits, plus a credit for a college course and the Saver’s Credit. As a result, she received a tax refund of more than $6,200, about $205 more than she would have received if she hadn’t opened the IRA. In addition, she saved $50 on state income taxes in Minnesota.

In other words, said Schrotenboer, the woman, who was worried because she had no savings for retirement, came out ahead. For one, she didn’t have to take the $500 out of her pocket to start the IRA. Rather, because of all the tax credits, she spent $245 to get the $500 IRA. The rest of the funds came from tax savings.

Further, she didn’t have to take any cash from her wallet. Once she gets her $6,200 tax refund check for the 2010 tax year, she will make the $500 deposit into her IRA.

It’s a strategy that financial planners sometimes suggest for people with little cash on hand. They say taxpayers can report an IRA on their tax forms, and then deposit refund money into the IRA by the April 15 deadline. To use the Saver’s Credit, complete Form 8880.

Of course, $500 isn’t a huge savings. But Schrotenboer said his client was eager to get started. If she adds $1,000 to her IRA every year until she retires at age 68 and earns 8 percent a year on average in a mutual fund, she could retire with about $200,000. If she were to start at age 45, she’d end up with just $62,000, even if her investments earn the same annually.

That’s why San Diego financial planner Glenda Moehlenpah thought it was a good idea when a college student borrowed money from his mother to open an IRA with $1,110. When he opened the IRA, he cut his federal and state taxes by a total of $217 and also received a $200 Saver’s Credit. So he needed to spend only $693 out of pocket for a $1,110 IRA.

If that money grows 8 percent a year on average until he retires, he should have $45,000 by retirement. If he invests $1,110 every year until retirement, he could have about $600,000. To experiment with potential savings, try the compounding calculator at moneychimp.com.

Gail MarksJarvis is a personal finance columnist for the Chicago Tribune and author of “Saving for Retirement Without Living Like a Pauper or Winning the Lottery.” Send her e-mail at gmarksjarvis@tribune.com.

2011, Chicago Tribune