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Tax Planning

Taking Time Off From Work Can Be A Secret Tax Opportunity

If you’re taking off time from work—e.g. sabbatical, leave of absence, or traveling the world—you might be able to take advantage of a special tax boon if you put money toward retirement.

Articles by Eric Bronnenkant

By Eric Bronnenkant
Head of Tax, Betterment  |  Published: May 1, 2019

The tax credit we discuss in this article is a rare triple tax advantage in life. If you qualify, all you have to do is commit to saving for retirement.

Follow six basic steps to see if you qualify, and be sure to consult a tax advisor for more information.

If you’re taking time off work, it’s probably not for tax reasons. But did you know that doing so could open up a major tax opportunity. It turns out, if you work less than half the year—without becoming dependent on another person—you may be able to take advantage of a special tax credit that could save you hundreds of dollars.

And, get this: This year may be one of the only times in your life you’re eligible.

Today, we’ll show you how you can potentially take advantage of the retirement saver’s credit. The only major move you have to make is to contribute to an IRA (which you might want to make a Roth IRA) or your employer-sponsored retirement plan, like a 401(k) or 403(b).

Why is this tax opportunity a big deal?

  1. It’s a win-win. You could potentially pay less in taxes simply by saving for retirement. But you’d have to save this calendar year. If you can put away money for your future self right now, while you aren’t working, you’ll actually get more back from Uncle Sam for your current self.
  2. Chances are, you may never be eligible to receive this tax credit again if you normally make more than $32,000 per year. It works this year because even if you make a high amount per month, you’re only working a few months in total for the year.
  3. It’s one of the rare triple tax advantages in life. This tax credit helps reduce how much you pay in taxes for this year, while letting you save into a Roth IRA or Roth 401(k) where gains are tax deferred, and you don’t have to pay taxes on withdrawals in retirement. In this way, it’s one of the few opportunities where the government offers three tax advantages at once.

How does this tax opportunity for not working work?

Getting the retirement saver’s credit during a year of taking time off isn’t going to be possible for everybody, but if you plan the next few months effectively, it might just work for you. Let’s walk through exactly what you’d need to do to take advantage.

1. You have to file taxes as an independent person.

If you’re taking time off in May, then depending on what choices you make next, you’ll either be independent for the year (supporting yourself in the government’s eyes) or you might be dependent on somebody else (like a family member). If you plan to work and live off existing savings while you take time off, then more than 50% of your lifestyle support will come from yourself, and you can file your taxes independently.

This situation opens up tax credits and deductions for you that otherwise would not be there because somebody would be claiming you as a dependent. One of these is the Retirement Savings Contribution Credit.

2. You have to be a full-time student for less than 5 months during the year.

In general, if you’re taking off to start school, you’re usually not eligible for this credit, but there are a few exceptions. For instance, if your school is on a quarter/trimester schedule and you’re only taking one term, then you could be eligible. Also, if you’re only enrolled part-time and still supporting yourself, then you could be eligible too.

3. Because you’re only working 50-60% of the year, your annual income will likely be significantly lower than in future years.

Because you’re only probably working six or seven months of the year, your federal tax bracket will be far lower than you might expect for future years. If you make a salary, and the annual amount is $50,000, then you could earn as little as $25,000 in gross income. You can qualify for the saver’s credit if your income for the tax year is less than $32,000 if you’re single and less than $64,000 if you’re married filing jointly.

The level of credit you get is tied to how much you save and depends on the size of your income. If you live and work in an area with a low cost of living, you could have a respectable entry salary of $36,000, and you could be eligible for the maximum credit. We have the entire Saver’s Credit income table below for 2019.

4. Start saving into a Roth IRA or employer plan when you’re ready.

If the three steps above apply, you’re ready to go after the saver’s credit. Your next step should be to start putting away money for retirement. We suggest using a Roth account, given that if you qualify for the credit, you’re almost certainly making less money than you expect to take during retirement. You can read more about why a Roth accounts might make sense for you, but the short of it is this: any employer plan you’re eligible for may not offer a Roth 401(k)/403(b), but you can always open a Roth IRA as an individual.

We make it easy to start a Roth IRA.

5. You need to have a tax liability.

The retirement savers credit is non-refundable which means that it cannot reduce your tax liability below zero. Some other credits like the Earned Income Tax Credit are refundable which means you may receive net payout (otherwise known as a negative tax) from the IRS. One of the challenges is keeping your income low enough to qualify for the credit but high enough to have a tax liability that will allow the greatest amount of the credit to be used.

6. Decide how much you’ll save each month.

The final step is to decide how much you’ll save and to set up automatic savings deposits.

To qualify for the credit at all, your gross salary isn’t likely to be more than $54,000 for the year (and more likely, it will be less)—or just over $4,500 per month before taxes. Since IRA contributions are limited to $6000, you’d need to contribute $2,000 to capture the maximum retirement saver’s credit, which could easily be a half of a month’s salary. In other words, maxing out might be aggressive as you’re getting your first post-collegiate paychecks. But even if you don’t max out, every amount saved supports your long-term retirement and your 6-month chance to get the retirement saver’s credit.

If you have a lot in savings, then you can definitely consider transferring savings account money or even taxable invested savings into a Roth IRA to take advantage.

Our auto-deposit tool can help fund your IRA.

FAQs about the Retirement Saver’s Credit

So, there you have it: the tax incentive that few people taking a sabbatical or time off work think about using, but many should consider. What other questions might you have?

Should I save into my new employer’s 401(k) or an IRA?

The great thing about this credit is that both your contributions to your employer’s plan and your IRA help you qualify. So, if you can contribute to an employer plan for part or all of the year, which one should you choose?

The answer is that it depends. If your employer plan offers a company match on your contributions, then you should certainly contribute there to capture the match—that’s free money. However, as explained above, it probably makes sense to contribute to a Roth plan—where you pay taxes now and not in retirement—so if your employer doesn’t offer a Roth 401(k) or 403(b), you may want to contribute to get the match, then save further in a Roth IRA. Moreover, some employer plans may have higher fees on the investments provided than you might find by opening a Roth IRA.

Is there any way I can qualify for the saver’s credit if I my salary is greater than $64,000?

There may be situations that help you qualify for the saver’s credit. For instance, if you get married this year—maybe taking a 6-month honeymoon using savings—then you and your spouse could feasibly qualify for a partial credit if your annual income is not more than $64,000 for the year—meaning your combined salary could be far greater.

Also, as you’ll see in the table below, the limits are based on adjusted gross income (AGI), which isn’t just your gross income. Certain life situations can adjust your income, lowering it in a way that may help you qualify or increase your credit. Examples of ways you can reduce your AGI include: pre-tax employer retirement contributions, health insurance premiums,  medical expenses, saving into a health savings account (HSA), moving expenses, capital losses, school tuition or fees you paid, or student loan interest.

What are the qualification rules for the credit?

See the table below full table of adjusted gross income limits and partial credit rates. Be sure to read the IRS’ detail on the Retirement Savings Contribution Credit too.

2019 Saver’s Credit
Credit Rate Married Filing Jointly Head of Household All Other Filers*
50% of your contribution up to $1,000 per spouse AGI not more than $38,500 AGI not more than $28,875 AGI not more than $19,250
20% of your contribution up to $400 per spouse $38,501 – $41,500 $28,876 – $31,125 $19,251 – $20,750
10% of your contribution up to $200 per spouse $41,501 – $64,000 $31,126 – $48,000 $20,751 – $32,000
0% of your contribution more than $64,000 more than $48,000 more than $32,000

 

Any tax information provided by Betterment is not a substitute for the advice of a qualified tax advisor. You should consult with your tax advisor to discuss tax-related concerns.

Contributing Authors

Jamie Cartwright
Content Marketing Manager, Betterment

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