A last-minute tax move for young workers

The young don't usually have money, but they do have time. And when it comes to saving, that time can eventually earn them bundles.

The last thing many young workers want to do is take proceeds from a hard-earned, often low-income job and put it toward retirement. But in fact, a little bit of savings now pays off big-time in a few decades, even if investment returns aren't always rosy. Recently, an expert worked the numbers for Consumer Reports and found that $5,000 invested every year from age 22 to age 29 would grow to $1 million by age 66--without additional funding--based on an average annual interest rate of 8 percent. While 8 percent seems unrealistic right now, over a long time horizon, it' s not unreasonable.

Here is an option for young workers--and their parents and grandparents--to consider: 

The saver's credit helps you save on your taxes if you're a low-wage earner and contribute to a retirement account. For young workers in particular, it's a good enticement to save. Funding an IRA and triggering the saver's credit also can be a way for parents and grandparents to give their working kids a leg up on the future without a direct handout.

Here's how it works: If you contribute to an IRA, 401(k), 403(b) or other qualified retirement plan, you're entitled to a saver's credit that reduces your federal taxes. Depending on your income, you'll get a credit of between 10 and 50 percent of what you contributed. The maximum saver's credit is $1,000 per person per year. It's too late to contribute to an employer's retirement plan to get a tax benefit for 2008, but you can still contribute to an IRA by April 15.

You're eligible for the 2008 saver's credit if your adjusted gross income is $26,500 or less as a single filer, $39,750 as a single head of household, or $53,000 as joint filers. There are other requirements: You can't be full-time student, you can't be used for an exemption on someone else's return, and you must be at least age 18. For more, download the 2008 version of IRS Publication 590, Individual Retirement Arrangements (IRAs).  

The saver's credit, together with an IRA or retirement-plan contribution, can deal a triple blow to your tax bill. The IRA deduction reduces your taxable income. It may also drop you to the 10-percent bracket from the 15-percent bracket, cutting your tax bill further. The saver's credit, subtracted from your tax, reduces what you owe even more--perhaps to zero.

Mark Luscombe, principal analyst of the tax and accounting group at CCH, a provider of tax information and software, helped me work the numbers for a single person making $18,000. Let's say you contribute $2,000 to an IRA, reducing adjusted gross income to $16,000. Subtracting the standard deduction of $5,450 and exemption of $3,500 drops that figure to $7,050--and into the 10-percent bracket. The tax on that $7,050 is $708. Subtracting a $1,000 saver's credit from that reduces taxable income to zero. In contrast, you'd have paid $960 by doing nothing.

Of course, most folks earning $18,000 a year would find it hard to put away $2,000. That's where a parent or grandparent can step in. They can help fund the young person's IRA, which triggers the saver's credit and the tax savings. The gift remains relatively out of reach in a retirement account, growing for the long term. 

--Tobie Stanger