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New retirement savings incentive may be an opportunity for "retirees".

The concept of retirement has changed. Today, rather than quitting work altogether, many people simply downshift from full-time employment to flextime or part-time positions, sometimes for the same employer, sometimes in completely different settings. Many baby-boomers hope to make this change as early in their lives as possible. Indeed, many have already done so. It has become quite common for people who have left their principal careers behind to continue working well into their 70s and beyond.

These early "retirees" may have modest taxable income, but still have adequate cashflow to support their living standards. For instance, a person changing to part-time work at 65 may delay receipt of Social Security benefits and withdrawals from qualified retirement plan accounts, and at the same time reallocate substantial investments into municipal bonds. The presence of compensation within that taxable income might allow an unexpected tax benefit, if a taxpayer is still willing to make contributions to a retirement plan or an IRA. A new credit intended to encourage saving for the traditional retirement years may be available to many people already in that age group.

For tax years 2002-2006, Sec. 25B provides a nonrefundable "savers credit" for "lower" income taxpayers who make voluntary contributions to certain qualified retirement plans, or to a traditional or Roth IRA. A taxpayer can claim the credit in addition to any deduction or exclusion that may otherwise apply. The credit is based on the amount the taxpayer contributed to any or all of these arrangements, net of any distributions received in (1) the immediately preceding two tax years and (2) the succeeding year, up to the return due date (including extensions). Eligible taxpayers must be over 18 (but not under any particular age), and cannot be full-time students or dependents of other taxpayers.

The maximum credit is $1,000 per individual or $2,000 for married joint filers, based on a $2,000 maximum creditable contribution at a 50% maximum credit rate. The credit is reduced in stages as adjusted gross income (AGI) increases. The full credit is only allowed for taxpayers with AGI up to $30,000 (married joint filers), $22,500 (heads of household) or $15,000 (all others); no credit is allowed when AGI exceeds $50,000, $37,500 or $30,000, respectively.

The interplay of this new credit and the other tax benefits of qualified retirement plans and IRAs can provide substantial leverage. When cash needs can be otherwise met, lower-income taxpayers (including older, semi-retired ones) should consider using these arrangements to extend their savings.

Regardless of age, a taxpayer with compensation can contribute to a Roth IRA. Except for a married-separate filer, the AGI phaseout rules for permissible contributions are not an obstacle, as the thresholds are considerably higher than those for the savers credit. With a Roth IRA, no requirement exists to begin minimum distributions at any time during an account owner's life. Therefore, as life expectancies increase, the avoidance of tax on account earnings (even without current deductibility of contributions) makes Roth IRAs attractive for older taxpayers. A 60-year-old might reasonably make Roth IRA contributions to save for a projected expense 30 years later. (Of course, a taxpayer can also consider traditional IRA contributions at this age.)

A taxpayer (whether employed full-time or part-time) who meets the eligibility requirements of an employer plan (such as a Sec. 401(k) plan) can continue to make salary-reduction contributions, regardless of age. Unless the taxpayer is a 5%-or-greater owner of the employer, no requirement exists to begin minimum distributions from such a plan while the taxpayer is still employed.

No matter their ages or whether they qualify for the savers credit, semi-retired taxpayers may still want to take advantage of the tax-deferral of qualified plans or IRAs. Beginning in 2002, contribution limits for most of these arrangements increased significantly. Also, taxpayers 50 years old and over can make "catch-up" contributions to these arrangements (in 2002, up to $1,000 for qualified plans, and up to $500 for IRAs), over and above the newly increased limits.

When a taxpayer can claim the savers credit (and when cashflow permits), the net cost of each dollar of tax-qualified retirement savings can be quite small. For example, in 2002, two over-50, married part-time workers, with AGI below $30,000, could each contribute $2,000 (or more, up to a maximum of $3,500) to Roth IRAs. They would receive a $2,000 credit ($1,000 per individual) on their joint return. The credit would not affect their bases in their Roth IRA accounts. The net cash outflow would be $2,000, with no tax on subsequent earnings or mandatory distribution requirements during the taxpayers' lifetimes. If instead, the taxpayers made contributions to traditional IRAs (which would be deductible if they met the AGI requirements for the savers credit) or qualified plans, they would also receive a current tax deduction. The net cash outflow would be substantially less. However, with traditional IRAs, the taxpayers would have to take lifetime distributions beginning at age 70 1/2.

The total dollar amount of all the tax benefits provided by qualified plan or IRA contributions in tandem with the savers credit is modest. However, as a percentage of each dollar committed, it can be quite attractive. Older taxpayers whose working lives have been scaled back (but not completely eliminated) are often still net savers. They might benefit, just as younger taxpayers can, from these "retirement" savings incentives.

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Article Details
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Author:Bakale, Anthony
Publication:The Tax Adviser
Geographic Code:1USA
Date:Aug 1, 2002
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