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Sheri Vargas of Houston wiped out her entire tax bill for each of the past four years by stashing about $1,000 a year in an individual retirement account. A single mother and preschool teacher who earns less than $22,000 a year, Vargas, 38, never thought she could squeeze enough money out of her tight budget to save for retirement. But Loyd Stegent, an old friend and financial planner, showed her that by claiming something called the retirement savings contribution credit she could turn even modest retirement savings into a boon.
You're eligible for the tax credit if you are single and earn $25,000 or less; head of a household and earn $37,500 or less; or married with a joint income of $50,000 or less. To qualify, you must be at least 18 years old, and you can't be a full-time student or be claimed as a dependent on anyone else's tax return.
Depending on your income, you can claim a tax credit of 10% to 50% of the amount you contribute to an IRA, 401(k) or other employer-based retirement plan, up to a maximum contribution of $2,000. (The lower your income, the larger the credit.) The maximum credit -- which reduces your tax bill dollar for dollar -- is $1,000 for an individual and $2,000 for a couple.
Stegent recommended that Vargas estimate her tax bill each year and then contribute just enough to an IRA to wipe out the balance by claiming the retirement-savers credit. Filing as the head of a household, Vargas was able not only to qualify for the full 50% credit but also to deduct her contribution to a traditional IRA. As a result, Vargas's $1,309 IRA contribution this year cost her only $525. In effect, Uncle Sam kicked in a matching contribution of 150%. The savers credit can also be used for contributions to a Roth IRA. With a Roth you don't get a tax deduction up front, but all withdrawals are tax-free in retirement.
The savers credit can't reduce your tax bill by more than you actually owe. But when combined with other refundable credits, it helped boost Vargas's tax refund to about $3,000 for each of the past four years. As a result, she had more money to spend on repairing her car, fixing up her house and paying down debts. "It made a huge difference," says Vargas, and even allowed her to splurge on a trip to Walt Disney World with her 10-year-old daughter, Samantha.
-- Mary Beth Franklin
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