Check Out the New Retirement Tax Credit

Physician's Money Digest, February15 2003, Volume 10, Issue 3

If you're a physician-investorapproaching retirement, there'ssomething besides approachinga work-free lifestyle to be happyabout. A tax credit provision in the2001 Tax Relief Act designed toencourage younger, lower-incometaxpayers to save for retirement mayalso benefit taxpayers who are nearlyretired. Before you think you'veretired and gone to heaven, however,you should know there is a catch. Forboth young and old, the tax creditonly lasts 4 years.


Here's how the credit works.Couples filing jointly with adjustedgross income (AGI) of no more than$30,000, and taxpayers filing singlywith an AGI of no more than$15,000, receive a 50% credit on theircontributions to a qualified retirementplan, such as a 401(k) or an IRA. Themaximum credit they can receive in ayear is $1000 (filing single) or $2000(couples filing jointly).

A credit, unlike a deduction, is adollar-for-dollar reduction of any taxliabilities. In this case, the creditclaimed is "nonrefundable" (ie, youdon't get any money back if youdon't owe any taxes). For example, toreceive a full $1000 credit, you'llneed to have at least $1000 inincome tax liabilities for the year. Ifyour tax liability for the year is only$500, for example, then $500 is themaximum you can receive as a credit.(If that $500 was already withheldthrough your paychecks, you wouldreceive the $500 back as a refund.)

Some taxpayers earning morethan the earning limits may qualifyfor smaller maximum credits. Forexample, couples with an AGI of$30,001 to $32,500 can receive a20% credit ($400 maximum), andcouples with an AGI of $32,501 to$50,000 receive a 10% credit ($200maximum). There is no credit availablefor a total AGI over $50,000($25,000 filing singly).

If you're just over one of theseAGI thresholds, a retirement contributionmay drop you into a lower taxbracket, thus allowing for a largercredit. For example, say your AGI is$32,000 (couple filing jointly). A$2000 contribution would drop yourAGI to $30,000, which would thenqualify you for a $1000 credit. Inshort, a $2000 contribution will costyou less than $1000 (you also wouldreceive a regular tax deduction of15% in addition to the credit).


The credit is not available to full-timestudents, dependents, or someonewho is not age 18 by the end ofthe tax year. The credit is alsoreduced, or even eliminated, for thecurrent tax year (and possible futuretax years) if you take money out of atax-deferred retirement account topay for such things as the first-timepurchase of a home or medical oreducation expenses.

Moreover, the credit is good onlyfor tax years 2002 through 2006.And remember, even if you don'tcontribute, or don't contribute themaximum in calendar year 2002, youmay be able to retroactively contributeas late as the filing date ofyour 2002 return. This applies tosome retirement accounts, such as anIRA or a simplified employee pensionplan, but not all.

One of the major criticisms of thiscredit, besides the 5-year tax window,is the fact that many lower-incomehouseholds find it difficult to scrapeup the funds to contribute to retirementaccounts, even with the credit.But one group of taxpayers who maybe able to take advantage of this taxbreak is the semiretired taxpayer.

Taxpayers heading toward fullretirement but still working part timemay have income low enough toqualify for the credit, and may still becontributing toward retirement accounts.However, semiretired individualswho already collect some retirementbenefits may have difficultyusing this program. The law statesthat taxable distributions from a pensionplan, Roth or regular IRA,401(k), or similar plan (but not fromSocial Security payments) reduces oreliminates the credit.

For example, if you receive $2000in pension plan income, that pensionplan income offsets $2000 incontributions you might make to anIRA or other retirement plan, andwould eliminate what's available forthe credit. Moreover, this offsetapplies not just to distributions receivedduring the current tax year,but to the previous 2 tax years andthe period following the current taxyear up to the return's due date,including all extensions.

Of course, you'll want to explorethis credit with your financial advisorbefore making any final decisions.Your advisor may find alternativeretirement and tax-saving strategiesthat are more appropriate for yourparticular situation.

This column is produced by the Financial

Planning Association (, the

membership organization for the financial

planning community.