Build Your Nest Egg and Save on Your Taxes

Don’t ignore the tax benefits of building a nest egg. A 401k and traditional IRA will give you a tax break today by allowing contributions to be considered tax deductions.

You may be getting ready to file your taxes before the April 15th deadline.  You can still make a contribution of up to $5,000 to your IRA ($6,000 if over 50) by the tax deadline and take a tax deduction for the contribution on your 2012 taxes.  You can build your nest egg and at the same time keep more of your hard-earned money.

If you opt for a Roth IRA you won’t see a tax break today, but qualified withdrawals in the future will come out tax free. If Uncle Sam is going to provide a benefit for saving money, take advantage of it.

Use Your Tax Refund to Build Your Nest Egg

After you file your taxes and find out you’re getting a tax refund, you can contribute some of your tax refund to your IRA and get a head start on tax savings for next tax year while growing your retirement.

Contribute a Little More

If you have a 401k at work or you opened up an IRA these vehicles are a great start, and if you’re already contributing something, that’s all the better. The thing is, you can always do more. Chances are you aren’t maxing out your 401k so there’s room for improvement.

You may be thinking that there’s simply no way you can afford to put more away, and it’s true that money is tight in this economy. But you don’t have to feel like you’re taking on another mortgage payment just to boost your retirement savings.

Start small. For example, if you’re currently contributing $200 a month, bump it up to $250. 50 extra dollars a month doesn’t seem like it will help, but over the long run it can be a big difference. Just the extra 50 bucks a month over the next 25 years tucked away in your retirement account will likely add up to $30,000 or more.

Whether you bump up your contributions 20 dollars a month or 200 dollars a month, the idea is to make it a habit every year. When you make a small bump to your monthly contributions your budget won’t take a noticeable hit.

Sure, you might feel the pinch initially, but it doesn’t take long before your spending adjusts and you completely forget about the extra money you’re putting into your nest egg. Now, if you make the same small increase each year it won’t take long before you’re putting a lot of money away toward retirement and you don’t even realize it. You will be thanking yourself when it comes time to rely on that money.

If you aren’t currently building up your nest egg with a 401k, IRA, or even just a savings account, now is a perfect time to start. Just like the advice above about starting small, that’s probably how you’ll want to start for the first time.

If you can’t afford to max out an IRA right now that’s perfectly fine and nothing to be ashamed about. Start with 25 or 50 dollars a month. Sure, that alone won’t give you the retirement of your dreams, but we’re just trying to build a foundation and get into the habit of saving.

Over time you will increase your contributions and it all adds up. Remember, every day that passes is one less day you have to save. You can’t get that time back, so save something, anything, and it will pay big dividends and help you save on your taxes.

Above all else, try to come up with a plan for the tax refund money before you even receive it. One of the worst things that can happen is you don’t have a specific goal in place for the money and it just gets deposited into your checking account.

It sits there and slowly, day by day, you chip away at the money without even realizing it. A few months later it’s gone and you’re not even sure where it went. So, don’t let this happen to you and come up with a use for the money before you have a chance to spend it.

Knock Down Debt

If I told you about an investment that had a guaranteed return of 15-30 percent or more, you’d probably view that as a little pot of gold and would like to invest, right? Well, if you carry a balance on a credit card, you can achieve these rates of return easily.

Most credit cards have an annual rate of anywhere from around 12 percent all the way up to 30 in some cases. Any balance you leave on that card will rack up those finance charges. For example, carrying a $2,500 balance on a card with a 25% APR will cost you $625 in interest a year!

That’s a lot of money being spent on nothing but the privilege of using a credit card and not paying it off right away. So, if you’re getting a tax refund this year and you’re carrying any high-interest credit card debt, one of the best things you can do is to use it to pay down the debt. It’s the easiest way to generate your own personal pot of gold even if you don’t see the total benefit immediately.

Padding Your Golden Years

What if you don’t carry credit card debt? There are still a few good uses for that tax refund. Chances are you haven’t been maxing out your IRA or 401k, and that’s OK. It’s difficult to fully fund these accounts with so many other financial obligations, but it’s something that should not be overlooked or pushed to the back burner just because retirement may be a few decades away.

If there’s tax refund money coming your way, consider dumping it right into an IRA or bump up your 401k contribution at work to make up for the extra money. If you thought paying off a credit card with a tax refund provided a good rate of return, you haven’t seen anything yet. Take that $2,500 tax refund and stick it into your retirement account. Even if you only see a modest return of around 5 percent a year, this year’s tax return would turn into a $8,500 pot of gold in about 25 years.

That may not seem like a lot, but what happens if you take your $2,500 tax refund each year and do the same thing? Now you’re thinking. If you did this, in 25 years your pot of retirement gold would be over $130,000. Think about that for a minute. All you’re doing is taking your tax refund money, that typically gets spent on odds and ends, and significantly padding your nest egg with virtually no effort.

Have a Little Fun

Paying down debt, saving for retirement, or building an emergency fund are not exactly the most exciting things to do with your tax refund money, but the results over time are more than worth it. If your financial house is pretty much in order already, then having a little fun with the money isn’t a bad idea if done right.

Instead of blowing it on a new laptop, television, or other gadget that will be thrown to the curb in a few years, think about long-lasting lifestyle upgrades like making sensible home improvements, which will not only provide enjoyment while you’re living there, but can increase the value of your home, which can put more money in your pocket when it’s time to sell.

Haven’t Filed?  You Can Still File so You Can Get Your Pot of Gold

If you haven’t filed your taxes yet you can still file so you can get your tax refund.  TurboTax will help you get the tax deductions and credits you deserve and help you keep more of your hard-earned money and turn it into a pot of gold.

As taxpayers, we are always looking for ways to maximize our income. The Internal Revenue Service (IRS) offers certain tax credits to help us with our expenses and savings surrounding two financial issues that are of great importance to our future: our education and retirement. These are some of the credits for which you may qualify and be one step closer to your financial success.

Education Tax Credits

If you, your spouse or one of your dependents paid for higher education or post-secondary expenses in 2012, you may qualify for one of these education tax credits: The American Opportunity Tax Credit or the Lifetime Learning Credit. These credits are available to help you pay for tuition or other related school expenses, as long as you didn’t pay for them with tax-exempt scholarships. TurboTax will help you choose the credit that helps you keep more of your money, but you cannot claim both of them.

The American Opportunity Tax Credit covers expenses during the first four years of post-secondary education. To qualify, the student must be studying towards a degree; enrolled in school at least part-time during the academic period; and not have been convicted of any drug-related offense.

The Lifetime Learning Credit is not as generous as the American Opportunity Tax Credit, but it is available for students who paid for any expenses related to qualified post-secondary education, whether it was a four-year program or not. Similar to the American Opportunity Tax Credit, this credit can be claimed for tuition and enrollment expenses. You can also claim expenses for required books or equipment if you paid the school directly for them.

Some expenses that are not eligible for these credits include expenses related to housing, insurance, transportation, medical expenses and others that are not directly related to the completion of any type of post-secondary studies. TurboTax can help you determine which credit will provide you with more benefits and which expenses you can include when claiming the credit.

Saver’s Credit

If you have  followed the wise advice of saving for your retirement and you have low or moderate income, the IRS could reward you with up to $1,000 ($2,000 if married and filing jointly) to help you save for your future. Contributions to investment accounts for retirement such as an IRA, Roth IRA, 401 401(k), 403(b), 457(b) and other voluntary contributions could help you meet the requirements to receive this credit, including:

• You must be at least 18 years old
• You cannot be claimed as a dependent by someone else
• You cannot be a full-time student
• You can claim up to 10%, 20% or 50% for the first $2,000 you saved
• The credit amount depends on your adjusted gross income, which cannot be more than:
  • $28,750 if you file as single, married filing separately, or widowed
  • $43,125 if you file as the head of a family
  • $57,500 if you file as married filing jointly

If you contributed any amount towards your retirement or have education expenses in 2012, TurboTax will help you determine if you qualify for these tax credits by asking you a series of simple questions while filing your taxes so that you can keep more of your hard-earned money.

Savers Credit

What is the Retirement Savers Credit?

The Retirement Savers Credit is a tax incentive to save for retirement. In exchange for you putting money in a qualified retirement account such as a 401(k), IRA, Roth IRA, or 403(b), the government reduces your taxes.  You might already know that the government allows an immediate deduction for contributions to many retirement plans—separate from this credit.  For example, every dollar you put in your 401(k) plan may reduce your taxable income, immediately saving you taxes.  One would think that would be enough of an incentive to save; and it is, for many.

Yet, possibly disappointed by how little most taxpayers save for their futures, the government created an additional incentive–the Retirement Savers Credit. What’s more, the credit is in addition to (not instead of) all the other existing tax incentives to save.

How Does the Credit Work?

Depending on your income level, a certain percentage of the amount you save for retirement is eligible for a credit.  The maximum savers credit may be as much as $1,000 ($2,000 for married couples).

Who Qualifies for the Credit?

Only those who save for retirement qualify for the credit.  Married savers filing jointly with an Adjusted Gross Income (AGI) below $56,500 qualify for the credit, as do Heads of Households with an AGI less than $42,375 and singles with an AGI less than $28,250.

What is the Credit Worth?

Unlike tax deductions which reduce your taxable income, credits reduce your tax–dollar for dollar. Said another way, whereas a $100 tax deduction for a low-income taxpayer might save him $10 or $15 in tax, a $100 credit saves him $100.  Note, however, that the Retirement Savers Tax Credit is not refundable.  This does not mean you can’t get money (e.g,. a refund) when you file your taxes if you take the credit. Rather, a tax credit’s status as nonrefundable simply means the credit cannot reduce your overall tax liability (including what you pay throughout the year via federal income tax withholding) to below zero.

If you’re skeptical about the credit and your ability to double-dip (i.e., take a deduction and a credit for the same savings), I hear you.  Twice benefiting (three times if you count the additional retirement security you create by saving) from the same decision is a true tax rarity.  If you qualify, take a few minutes to consider saving for retirement.  Although you might feel financially stretched and unable to save, the Retirement Savers Credit just might make saving within your reach.

Something that you also want to check are taxes you’d be expected to pay, specifically taxes on your Social Security income.

Social Security

Will My Social Security Income Be Taxed?

Not everyone has to pay taxes on their Social Security benefits.  To see if your Social Security will be taxed, you have to look at your *combined income and your marital status.  According to IRS Publication 915 (Social Security and Equivalent Railroad Retirement Benefits), the income thresholds for Social Security are:

• If you’re single and your total combined income for the year is between $25,000 and $34,000, then up to 50% of your benefits can be taxed.
• If you’re single and your total combined income for the year is greater than $34,000, then up to 85% of your benefits can be taxed.
• If you’re married filing jointly and your total combined income for the year is between $32,000 and $44,000, then up to 50% of your benefits can be taxed.
• If you’re married filing jointly and your total combined income for the year is greater than $44,000, then up to 85% of your benefits can be taxed.

* Combined Income-Combined income when figuring tax on social security income is Adjusted Gross Income plus nontaxable interest plus 1/2 of social security benefits.

SSA-1099: You’ll Need It

If you’re already receiving Social Security benefits, you can use your SSA-1099 form (Social Security Benefit Statement) to determine how much of your benefits are taxable. You should receive it in January and should have the information required for the previous year.

When you file taxes, you’ll need this form, so please keep it in a safe place.  Don’t worry about figuring how much of your social security income is taxable.  TurboTax easily makes the behind the scenes calculations and figures out the accurate amount of social security income that is taxable based on your income entries.

Thoughts on Social Security Income

I’d love to hear your stories. Are you preparing to retire soon? Have you considered your Social Security income?

Finance

Here are a few tips to help you get started:

Reduce Your Credit Card Debt

Did you know that 14 million Americans are still paying off their holiday bills from 2010? Or that the average household currently has about $15,000 in credit card debt? As you rethink needs versus wants in 2012, regain control by paying down the balance of the credit card with the highest interest rate first.  There are free sites out there like Mint.com that will help you establish a budget and goals.  Alternately, look into doing a balance transfer which will help you consolidate high-interest rates to less expensive cards.

Save More & Spend Less

Get this: About 60% of overall purchases are spontaneous, and the average cost of an impulse buy is about $100. Stop the madness!  You can put more cash in your pocket in 2012 by separating your wants from your needs.  Need cash immediately or want to kick start your savings? File your taxes now! Tax refunds are averaging about $3,000 and if you choose e-file and direct deposit you may get that money back in your pocket in as few as 7 days versus 4 – 6 weeks for a paper return. You can also save on fees and learn about your fiscal health by using TurboTax.

Boost Your Credit Score                  

These days, you need a score of about 720 or higher to get the best rates. Score high and you can save thousands of dollars; score low, and it’s not only tough to get a loan, but also rent an apartment or even land a job. Make 2012 the year you improve your credit score. You can do this by paying your bills on time (that accounts for 35% of your score), paying down your debts (the amount you owe is 30% of your score), and keeping the credit card spending under control. You should utilize no more than 30% of your available credit and ideally only 10%.

Fund An Emergency Account

Fewer than four in ten Americans have a fully funded rainy day account! That’s a scary prospect, given how fragile this recovery is. You need a cushion: if possible, at least six months to a year’s worth of salary set aside in an accessible account (such as a money market account) to cover unexpected expenses or replace interrupted income.

Get Serious About Retirement

First, run the numbers to see just how much money you’re going to need to live comfortably in your retirement. Then, get to work. Stash away as much as you can into an employer-sponsored plan (the contribution limits have gone up from $16,500 in 2011 to $17,000 in 2012; $22,500 for those 50 years of age or older), and take full advantage of company matches.  You should also consider spending less, working longer and redefining your vision of retirement.

As long as an individual meets certain criteria laid out by the IRS, this strategy will offer hefty tax savings for individuals and much-needed cash for numerous charitable organizations.

Qualified Charitable Distribution

Tax Law Timeline

The Pension Protection Act of 2006 allowed taxpayers age 70 1/2 and older to exclude from their gross income what would otherwise be taxable distributions from their IRA if they were paid directly to a charity.

This law has been extended for the last 4 years, and is currently extended through December 2011 by the Tax Relief Act of 2010.

This tax legislation extends Qualified Charitable Distributions – an IRA distribution paid directly to a charitable organization from IRAs – through the end of this year. QCDs are excluded from the taxpayer’s gross income for federal tax purposes and may be counted toward an individual’s Required Minimum Distribution (RMD) if those minimums have not yet been satisfied.

Guidelines to Determine Qualified Charitable Distributions

• Individuals must be 70 1/2 years of age or older when the contribution is made.
• Contributions must come from traditional or Roth IRAs. According to the IRS, QCDs cannot be made from employer-sponsored IRAs (Simplified Employee Pensions; SEP-IRAs), Savings Incentive Match Plans for Employees (SIMPLE-IRAs), or from defined contribution retirement plans (for example, 401(k) plans or 403(b) plans).
• Charities receiving the contribution must be eligible to receive tax-deductible charitable contributions; 501(c)(3) organizations. This seems rather obvious, but you need to be smart and research the charity prior to your donation.
• The maximum QCD is $100,000; however, a spouse can also make a $100,000 qualified charitable distribution within the same year if the couple files a joint income tax return.
• The $100,000 max limit doesn’t apply to the overall charitable deduction limit. Therefore, individuals are able to make charitable contributions in excess of 50% of their adjusted gross income.
• The distribution must be a “trustee-to-trustee transfer”. This means that the money doesn’t touch your bank account; instead, it goes directly from your IRA account to the charity that you have chosen. A distribution to a recipient other than a charity will not be tax free, even if that recipient donates the money to a charity.
• Qualified distributions for 2011 must be made by December 31, 2011.

Benefits of This Extension

There are three major areas of benefit when dealing with this tax-free extension.

First, the extension gives an incentive for individuals over 70-1/2 to donate. These incentives could possibly be a deciding factor for many people considering what to do with their IRA distributions.

Although the individuals get a tax break, extending this tax legislation benefits charities who are in need of donations by making it easier and cheaper for donors to give. Remember, charities need funds to continue doing good work around the country and around the world.

Second, the tax relief extension benefits the donor by allowing the exclusion of up to $100,000 of the the QCDs from their gross income in 2011. This is the tax-break highlight of the program extension, especially for this last month of the year.

Third, for those of you who have Required Minimum Distributions, QCDs satisfy RMDs that you would normally be forced to receive from your IRA, just as if you had received an actual distribution from the plan. This means your RMD will satisfy your required distribution amounts as well as give you all of the tax benefits of a qualified charitable distribution.

However, you do not get to deduct QCDs as a charitable contribution on your federal income tax return. That’s double dipping.

Why This Extension Is Important To You

Typically, deductions for charitable cash contributions are limited to 50% of a taxpayer’s AGI. Individuals who want to make a large charitable donations above that limitation are able to do so under this extension.

This is an important tool because the QCD’s exclusion from an individual’s gross income provides a solution for making charitable deductions for taxpayers who are not able to itemize their deductions (i.e. they take the standard deduction).  If you are a taxpayer over 70-1/2, who is lucky enough to have a paid off mortgage, you may not be lucky enough to itemize your deductions since mortgage interest usually plays a big part in you being able to itemize deductions.  If this is the case, paying qualified charitable distributions directly from your required minimum distribution(tax-free) will greatly help your tax situation.

Other areas of importance are that the extension makes this process less time consuming and less expensive. Without utilizing this tax-free extension, an individual would see an increase in paperwork and a decrease in benefits.

Who Should Make Qualified Charitable Distributions?

Typically, there is a limit of 50% of an individual’s Adjusted Gross Income that is available for charitable deductions. Taxpayers who want to make a large charitable donation above that limitation are ideal candidates to benefit from the QCD extension.

Another possible candidate might be someone who desires to make a large charitable donation, but their only financial vehicle is a large IRA balance. In this situation, if the individual took a normal IRA distribution outside of the tax-free QCD extension, they would be subject to fees, taxes, and a litany of other possible consequences (including an increase in taxable Social Security income or a rise in Medicare Part B Premiums).

Other individuals might simply want to donate their entire RMD and still enjoy the tax benefits by making the contribution through the tax-free QCD.

Remember, qualified charitable distributions for 2011 must be made by December 31, 2011.  If you decided to make this thoughtful charitable contribution, it will be indicated on your Form 1099-R.  Don’t worry,  TurboTax will easily guide you to enter the necessary information from your qualified charitable distribution.

Contributions to Your 401(k)

The 401(k) plan contributions you elect to make come directly out of your salary. Since the contributions are made with pre-tax dollars, your employer does not include these amounts in your taxable income for the year. At the end of the year, when you receive your W-2 form that shows your earnings, you will notice that your wages subject to federal income tax are lower because of your 401(k) plan contributions. Since the wages are not counted in your taxable income to begin with, you do not take a deduction when you file your return. However, when you prepare your tax return, it’s possible to calculate how much income tax your 401(k) contributions saved you. For example, if you contribute $8,100 to your 401(k) during the year and that amount would be taxed in the 33 percent bracket if included in taxable income, then your tax savings is $2,673.

Increase in Your Take-Home Pay

Your 401(k) plan contributions also reduce the amount of your income tax withholding. Each time you get paid, your employer withholds money for your federal income taxes based on your expected taxable income. However, if you make 401(k) plan contributions, the amount of money subject to withholding will decrease since your taxable income is less than your actual salary. The result is more money in your take-home pay each pay period.

The Savers Tax Credit

In addition to the tax savings available for your contributions to a 401(k), the IRS also offers the Savers Credit if your Adjusted Gross Income (AGI) doesn’t exceed certain maximums. This credit offers a dollar-for-dollar reduction of your federal income tax bill. In 2010, single taxpayers whose AGI doesn’t exceed $27,750 can receive a credit up to $1,000 and married taxpayers with an AGI of $55,500 or less can receive up to $2,000. If your AGI doesn’t exceed these thresholds, you are at least 18 years of age and are not a dependent to another taxpayer, then you need to prepare IRS Form 8880 with your tax return to claim the tax credit.

Misconceptions About 401(k) Contributions

The contributions that you make to a 401(k) plan only reduce your income taxes, not your Social Security and Medicare taxes. These two taxes only apply to your earned income, but you do not get to claim any deductions before these taxes are assessed. For example, if your gross wages for the month are $2,500 and you contribute $400 to your 401(k) plan from it, there is withholding on the full $2,500 for Social Security and Medicare even though for federal income tax purposes, there is withholding on $2,100.

Just who qualifies as a middle class these days? The Middle Class Task Force says that the majority of Americans describe themselves as middle class or working class. “Middle class families are defined by their aspirations more than their income,” its report says. Those aspirations include home and auto ownership, retirement security and college education for children.

To help American’s achieve those goals, the Obama administration has come up with several tax proposals. The president addressed these initiatives in his State of the Union address:

Automatic Retirement Savings for Workers

Roughly half of the American workforce—some 78 million workers—does not have a retirement plan at work. The administration would like their employers to automatically enroll employees in a tax-deferred retirement plan, known as a workplace IRA.  (Employees will be able to opt-out of the plans.)

Contributions to these plans will be voluntary for workers. The smallest firms—although the White House didn’t specify how small—would be exempt.

To encourage workers to save in these automatic plans along with other qualified retirement accounts, the Savers Tax Credit will match contributions. The proposal calls for matching 50% of the first $1,000 of retirement contributions by families earning less than $65,000. There’s a partial credit for families earning up to $85,000.

The automatic retirement savings is based on a large body of research in the area of behavioral finance that shows people save more when decisions are made for them. A study from the Employee Benefit Research Institute finds that employers adopting automatic enrollment in their 401(k) retirement plans have also generally increased the “employer match” to participant’s accounts—in some cases, by a significant amount.

Boost Childcare and Dependent Care Tax Credit

There is some additional tax relief for an estimated 38 million Americans who are providing unpaid care to an aging relative. And many of them are part of the sandwich generation—they are also caring for their children while looking after elderly family members. The administration wants to practically double the child and dependent care tax credit for families earning less than $85,000 a year. (Credits will rise from 20% to 35% of qualifying expenses.)

Almost all eligible families making under $115,000 a year could see a larger credit, too. Families could claim up to $3,000 in expenses for one child or $6,000 for two children. The maximum credit for a family with two children making $80,000 a year would increase from $1,200 to $2,100.

Student Loan Relief

Recent college graduates are often saddled with more than $23,000 in debt. In a tough economy with few jobs, they are struggling to pay off their student loans. The administration is calling for a cap of student federal loan payments to 10% of a student’s income (above a basic living allowance).

Here’s how it works: the monthly payment for a single borrower earning $30,000 who owes $20,000 in college loans would be $115 a month – as opposed to $228 a month under the standard 10-year repayment plan, according to the plan. The income cap could cost the government about $1 billion over the next five years, estimates Mark Kantrowitz of Finaid.org.  “This proposal would yield meaningful repayment relief to hundreds of thousands of borrowers whose federal student loan debt exceeds their income,” Kantrowitz says. “It would cut their monthly payments by one-third and forgive the remaining debt sooner.”

You can find more information about the tax proposals from this White House Fact Sheet.