The government wants to help consumers save — for retirement, for an emergency fund or for other goals — during the tax season. It is, after all, a good time to think about jump-starting a savings program, because so many taxpayers get refunds.
According to Internal Revenue Service figures, about three-quarters of federal income tax filers claim refunds, and those refunds last year averaged more than $2,260.
This year, there are several ways consumers can take advantage of the tax system to boost savings, experts point out. Among them is a new option for having refunds split up and deposited directly into more than one account. Others are the saver’s credit for middle- and low-income families, and the traditional tax deferral for contributions to retirement accounts.
A number of advocacy groups, including the nonprofit Retirement Security Project and the AARP, have been working to alert consumers about the new split refund, which was authorized by the Pension Protection Act of 2006.
Attorney Mark Iwry, a former U.S. Treasury official who is a senior adviser to the Retirement Security Project in Washington, D.C., said most families have typically had a tax refund check mailed to them or deposited directly into a checking account, from which it was spent.
“That refund is the biggest hunk of money that many people will see in the course of the year,” Iwry said. “The idea was, why not encourage people to save a little bit of it?”
By allowing taxpayers to split their refunds, the government hopes some of the refund money will make its way into savings accounts, including those earmarked for retirement or college, Iwry said.
Iwry said consumers can split their refunds for deposit in up to three accounts by attaching IRS Form 8888 “Direct Deposit of Refund to More Than One Account” to their tax return. They could include an emergency savings account and an Individual Retirement Account, he pointed out.
“It’s a pre-commitment to savings, because the money isn’t in your hot little hands yet,” he said.
Another savings device is the saver’s credit, which rewards families with adjusted gross income of $50,000 or less if they set money aside in IRAs and company-sponsored retirement accounts like 401(k)s.
The saver’s credit had been scheduled to expire at the end of this year but was made permanent by last year’s Pension Protection Act.
It’s a “nonrefundable” credit, which means taxpayers who qualify for it don’t get it in cash. But they can use the credit to reduce the taxes they owe on a dollar-for-dollar basis, said Mark Luscombe, principal tax analyst at CCH Inc. of Riverwoods, Ill. The company, a division of Wolters Kluwer, provides tax information and services to tax professionals.
A worker who contributes $2,000 to an IRA or qualified retirement account can claim a savers credit of up to $1,000, he said. The amount of the credit varies between 10 percent and 50 percent depending on total income, he added, with the highest credits going to the lowest income families.
Families can apply for the credit on IRS Form 8880, he said.
Taxpayers also can boost their savings with contributions to traditional IRAs and 401(k)s. Money contributed to these accounts grows tax deferred until it is withdrawn in retirement.
This year, tax filing day is April 17. That’s because the traditional filing day of April 15 falls on a Sunday and April 16 is a legal holiday in Washington, D.C., where the IRS is located.
That means that taxpayers have until April 17 to put pretax money of up to $4,000 into their IRAs for 2006; those over 50 can make an additional $1,000 “catch-up” contribution. The limits remain the same in 2007.
Luscombe warned that taxpayers who plan to fund their 2006 IRAs out of split refund money should make sure they file their tax forms well in advance of the April 17 deadline to ensure the refunds get deposited early enough to qualify. Or they can take the easier route and apply the money to their 2007 IRAs, he said.
The limit on employee contributions to 401(k) and other company-sponsored accounts rises to $15,500 in 2007 from $15,000 in 2006; people 50 and over can make additional $5,000 contributions both years. Contributions to these programs must be made before Dec. 31 of each year.