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Retirement Savings Contribution Credit and pension
Old 06-14-2021, 08:45 AM   #1
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Retirement Savings Contribution Credit and pension

One of the silver linings of my husband's unexpected early retirement (prompted by a COVID layoff last year) is that our income will be low enough to take the Retirement Savings Contribution Credit. Because I am significantly younger and am still working, we plan to continue to contribute to our Roth IRAs. Because we file MFJ and my income is greater than our combined contributions, we can both still contribute.

However, my husband has a modest (~$1000/mo) pension that he started taking recently to supplement my income. We decided that he would take the pension early at the reduced amount and that will enable him to wait until 70 to start drawing SS. This is a defined benefit pension to which he did not contribute.

My question is whether this would reduce (and thus eliminate) our contributions from eligibility for the Saver's Credit (form 8880, line 4). It makes sense that you could not take the credit for contributing to an IRA in the same year as taking a distribution from an IRA. However, this pension seems different because he did not contribute to it. In fact, the IRS states: "In general, your qualified retirement savings contribution is not reduced by distributions you received from a plan in which you could not make a qualified retirement savings contribution." (https://apps.irs.gov/app/IPAR/resour...excldplan.html)

But I am stuck on the language "could not make" versus "did not make." We definitely "did not" make contributions and he "could not" make contributions to this exact pension, but his employer did have a "voluntary pension account" to which he could but did not contribute. That would have increased the pension amount, but seems to technically be a separate account when I read all the fine print in the retirement benefits handbook.

What do you think? Is this common or unusual? Will it be a red flag to have pension income on a 1040 and also take the Saver's Credit? It is less important to me to be able to take the credit than it is to actually know the correct answer to this question so I can do our taxes correctly. BTW, I have always done our taxes "by hand" and currently use the IRS Free Fillable Forms.

Thanks for reading!
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Old 06-14-2021, 09:56 AM   #2
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Certainly appears OP qualifies, and a good chance that OP's spouse qualifies, from my quick reading.

The total max credit is $2,000

I would claim it, as the cost of being wrong is having to pay back whatever credit is deemed wrong, and some interest which would be small. So barely any loss, and OP seems to have researched more than the average person would.

Not claiming it, means missing out on $2,000.

I've been called and sent a letter by the tax folks a few times about my returns, I have been wrong sometimes and correct the other times, they usually just want more information/clarification on some issue.

The most annoying time was when I stated some incorrect value, so they called me on it, and I had to fix the form (by hand) which then carried the new numbers through lots of other pages (all had to be fixed). The tax owed/refund remained the same regardless. I told the tax person fixing this would make no difference to the taxes, but they insisted as the return had to be correct. So I did it.

Now I use software as $25/yr saves me a ton of work if I need to fix something, and it allows me to play "what if" situations to see what happens to my taxes, and I don't make math mistakes on the taxes.

OP probably will qualify for free tax software (go through IRS site) next year due to low income.
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Old 06-14-2021, 10:25 AM   #3
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My DH gets a pension that he did contribute to. I make IRA (Trad and Roth) contributions based on my own earned income. His pension is much larger then my IRA contributions and in our case we do not qualify for the Savers Credit.

I use an online tax filing website and they always explain that we do not qualify because his pension is larger than my IRA contributions.

Your question is interesting because in your case your DH did not contribute to the pension.

What's the specifics of his 1099-R? What's in Box 7 (Distribution Code)?

You could try putting the info in a free tax filing site and see what comes up. I use www.freetaxusa.com
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Old 06-14-2021, 02:30 PM   #4
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See this quote from Understanding the IRS savers credit - Bogleheads.org:
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With respect to reductions, there has been one continuing issue since Day 1 of the credit. The issue affects those receiving DB pension payments for plans to which they cannot contribute. Tax code Sec 25B makes this clear, but Form 8880 does not. Private DB pensions cannot be contributed to by the employee, however many govt pension plans require employee contributions or accept service type purchases from after tax money, both of which would be treated as a contribution by the employee reducing contributions eligible for the savers credit.
The poster of that quote is highly regarded for his knowledge of tax issues.
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Old 06-14-2021, 04:05 PM   #5
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I'm pretty familiar with this since DS has utilized for the last 5 years or so.

The defined benefit pension would be part of your income but not a retirement plan withdrawal.

One interesting play depending on your numbers is to have your retirement contributions be a mix of both deductible tIRA contributions and Roth contributions to optimize the credit. I recall some years where if we did some deductible tIRA contributions that it reduced DS's income so that he was in a more lucrative retirement credit tier that resulted in a higher retirement savings tax credit and then we added Roth contributions on top of that.

For example, for 2021 and MFJ, you get a 50% credit if your AGI is below $39,500, 20% for AGI of $39.501-$43,000 and 10% for AGI of $43,001-$66,000.

So let's say that your AGI before any retirement contributions is $42,000 and you plan to make $4,000 of retirement plan contributions.... you would want to make a $2,501 deductible tIRA contribution that would reduce your AGI to $39,499 so you get the 50% credit... then the remaining $1,499 as a Roth contribution. Your credit would then be equal to the maximum credit of $2,000.... 50% of the $4,000.

If you made a $4,000 contribution to a Roth then your credit would only be $800 (20% of $4,000).

So by splitting your contributions wisely you get a $2,000 credit rather than an $800 credit.

That's the general idea but it get more complicated since the credit can't exceed your tax... IOW, it isn't a refundable tax credit so in the example above the maximum credit would be $1,430 (tax on $39,499 of AGI assuming standard deduction for MFJ undeer age 65)... rather than $2,000.

So adding that constraint I would make a $2,860 contribution... $2,501 deductible tIRA to reduce income to $39,499 for the 50% tier and $359 Roth... the $2,860 at a 50% would be a total credit of $1,430 totally offsetting the tax.

There are so many moving pieces that I find it easiest to just put in DS's return with no retirement contributions and then "play" with the numbers to try to optimize the result.
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Old 06-14-2021, 06:05 PM   #6
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So adding that constraint I would make a $2,860 contribution... $2,501 deductible tIRA to reduce income to $39,499 for the 50% tier and $359 Roth... the $2,860 at a 50% would be a total credit of $1,430 totally offsetting the tax.
Or $2501 deductible tIRA and then as much as one can afford into Roth. Hard to beat a 0% marginal tax rate cost for a Roth contribution.
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Old 06-14-2021, 08:03 PM   #7
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Originally Posted by Sue J View Post
My DH gets a pension that he did contribute to. I make IRA (Trad and Roth) contributions based on my own earned income. His pension is much larger then my IRA contributions and in our case we do not qualify for the Savers Credit.

I use an online tax filing website and they always explain that we do not qualify because his pension is larger than my IRA contributions.

Your question is interesting because in your case your DH did not contribute to the pension.

What's the specifics of his 1099-R? What's in Box 7 (Distribution Code)?

You could try putting the info in a free tax filing site and see what comes up. I use www.freetaxusa.com
There is a "7" in Box 7, which the instructions indicate is a "normal distribution."
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Old 06-14-2021, 08:12 PM   #8
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See this quote from Understanding the IRS savers credit - Bogleheads.org:
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Thanks! Tax code sec 25B is what I linked to as well. That is encouraging! I am still slightly concerned that the existence of a voluntary pension account, to which DH did NOT contribute, but could have, would somehow disqualify us. His retirement handbook does refer to it as a "voluntary pension account,' which seems to indicate that it is separate from the DB pension he is receiving. Oddly, we did not even know he had it until a few months before he was laid off.
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Old 06-14-2021, 08:21 PM   #9
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Originally Posted by pb4uski View Post
I'm pretty familiar with this since DS has utilized for the last 5 years or so.

The defined benefit pension would be part of your income but not a
retirement plan withdrawal.

One interesting play depending on your numbers is to have your retirement contributions be a mix of both deductible tIRA contributions and Roth contributions to optimize the credit. I recall some years where if we did some deductible tIRA contributions that it reduced DS's income so that he was in a more lucrative retirement credit tier that resulted in a higher retirement savings tax credit and then we added Roth contributions on top of that.

For example, for 2021 and MFJ, you get a 50% credit if your AGI is below $39,500, 20% for AGI of $39.501-$43,000 and 10% for AGI of $43,001-$66,000.

So let's say that your AGI before any retirement contributions is $42,000 and you plan to make $4,000 of retirement plan contributions.... you would want to make a $2,501 deductible tIRA contribution that would reduce your AGI to $39,499 so you get the 50% credit... then the remaining $1,499 as a Roth contribution. Your credit would then be equal to the maximum credit of $2,000.... 50% of the $4,000.

If you made a $4,000 contribution to a Roth then your credit would only be $800 (20% of $4,000).

So by splitting your contributions wisely you get a $2,000 credit rather than an $800 credit.

That's the general idea but it get more complicated since the credit can't exceed your tax... IOW, it isn't a refundable tax credit so in the example above the maximum credit would be $1,430 (tax on $39,499 of AGI assuming standard deduction for MFJ undeer age 65)... rather than $2,000.

So adding that constraint I would make a $2,860 contribution... $2,501 deductible tIRA to reduce income to $39,499 for the 50% tier and $359 Roth... the $2,860 at a 50% would be a total credit of $1,430 totally offsetting the tax.

There are so many moving pieces that I find it easiest to just put in DS's return with no retirement contributions and then "play" with the numbers to try to optimize the result.
Yes, I was considering this method of splitting contributions between tIRA and Roth to max out the credit. Thanks for laying it out in such detail! This method would also increase our APTC for our ACA plan. However, I want to make sure we are eligible for the credit before I do this. If we later find out that the pension DOES reduce/eliminate our credit, and we would not otherwise have contributed to tIRAs in place of Roth, then it would be a much bigger issue than just paying back the credit plus interest.
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Old 06-14-2021, 08:49 PM   #10
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Or $2501 deductible tIRA and then as much as one can afford into Roth. Hard to beat a 0% marginal tax rate cost for a Roth contribution.
Yes, we were thinking of still maxing out IRAs for a while if we can. So I think we would either put it all in Roth or put just enough in tIRAs to max the credit and the rest in Roth.
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Old 06-14-2021, 08:51 PM   #11
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I am still slightly concerned that the existence of a voluntary pension account, to which DH did NOT contribute, but could have, would somehow disqualify us.
Seems highly unlikely.

Consider a related question, Are You Covered by an Employer Plan?, when it comes to determining tIRA deductibility. For that, the IRS says (emphasis added) "Generally, you are covered by a defined contribution plan for a tax year if amounts are contributed or allocated to your account for the plan year that ends with or within that tax year."

Thus, even if one is eligible to contribute to a 401k, if no such contributions (including no employer contributions) are made to the 401k in a given year, the employee is not covered by that plan.
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Old 06-14-2021, 08:51 PM   #12
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Originally Posted by pb4uski View Post
I'm pretty familiar with this since DS has utilized for the last 5 years or so.

The defined benefit pension would be part of your income but not a retirement plan withdrawal.
So you have done this and it has been accepted by the IRS?
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Old 06-14-2021, 08:53 PM   #13
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Seems highly unlikely.

Consider a related question, Are You Covered by an Employer Plan?, when it comes to determining tIRA deductibility. For that, the IRS says (emphasis added) "Generally, you are covered by a defined contribution plan for a tax year if amounts are contributed or allocated to your account for the plan year that ends with or within that tax year."

Thus, even if one is eligible to contribute to a 401k, if no such contributions (including no employer contributions) are made to the 401k in a given year, the employee is not covered by that plan.
Ah! This is very helpful!
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Old 06-14-2021, 10:33 PM   #14
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So by splitting your contributions wisely you get a $2,000 credit rather than an $800 credit.

That's the general idea but it get more complicated since the credit can't exceed your tax... IOW, it isn't a refundable tax credit so in the example above the maximum credit would be $1,430 (tax on $39,499 of AGI assuming standard deduction for MFJ undeer age 65)... rather than $2,000.
So, wait. In what situation could one (or two, because MFJ) ever get the full $2000 credit? Is that even possible?
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Old 06-14-2021, 11:06 PM   #15
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So, wait. In what situation could one (or two, because MFJ) ever get the full $2000 credit? Is that even possible?
Yes, it's not usual but it is possible. E.g., if the "Excess advance premium tax credit repayment" amount is high enough.
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Old 06-15-2021, 03:43 AM   #16
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Yes, it's not usual but it is possible. E.g., if the "Excess advance premium tax credit repayment" amount is high enough.
+1 excess advanced premium tax credit repayment or other taxes, which is why you have to work through the forms
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Old 06-15-2021, 05:09 AM   #17
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So you have done this and it has been accepted by the IRS?
No, because DS is working so he isn't collecting defined benefit pension benefits.

I am collecting defined benefit pension benefits but I do not consider them to be retirement savings account withdrawals.... I don't view them as retirement account withdrawals but it appears that the IRS does for the purpose of the retirment savers credit... see https://taxtopics.net/Sec4974c.htm#:...0beneficiaries.

Quote:
The instructions for Form 8880 state that you must include any distribution you receive from any of the following plans:

- Traditional or Roth IRAs.
- 401(k), 403(b), governmental 457, 501(c)(18)(D), SEP, or SIMPLE plans.
- Qualified retirement plans as defined in section 4974(c) including the federal Thrift Savings Plan).
Unfortunately, the instructions do not include any definition of a Sec. 4974(c) qualified plan.

For most taxpayers, the most important part of Sec. 4974(c) includes a plan described in section 401(a) which includes a trust exempt from tax under section 501(a). What does this mean?

Sec. 401(a) includes stock bonus, pension and profit sharing plans of an employer for the exclusive benefit of his employees or their beneficiaries.

Basically, what Form 8880 is telling you is that any distribution from just about any employer pension plan, must be used to offset any eligible contribution. This does include defined benefit plans (a plan that typically bases your retirement benefits on age, service time and earnings).
So:
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I'm pretty familiar with this since DS has utilized for the last 5 years or so.

The defined benefit pension would be part of your income but not a retirement plan withdrawal.
...
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Old 06-15-2021, 07:04 AM   #18
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+1 excess advanced premium tax credit repayment or other taxes, which is why you have to work through the forms
I worked through this a little bit with my eyeballs yesterday and the excess APTC repayment and the AMT seem to be the only two items that would give you the full RSCC. Because of the ordering of page 2 of the 1040, anything else that is an additional tax is after the point where the nonrefundable RSCC enters the picture.

It would seem highly unlikely that someone in this kind of tax situation would be subject to AMT, but I suppose it's possible. The APTC is probably much more likely.

Agree on working through the forms (or just whipping out tax software).
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Old 06-15-2021, 07:48 AM   #19
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This thread is jogging my memory some. DS had a couple years where he was earning less and was on ACA subsidies and I recall we designed his retirement plan contributions to optimize them so his retirement savers tax credit was equal to his total tax so he got a full refund of all his federal withholdings.
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Old 06-15-2021, 08:23 AM   #20
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+1 excess advanced premium tax credit repayment or other taxes, which is why you have to work through the forms
Maybe self-employment tax if relevant? Also, I guess tax liability would have been a little higher before the standard deduction and exemption changes a couple of years ago.

Still, I'm glad you pointed out that we're not likely to be able to use the entire $2000 credit even if we strategically contribute to tIRAs. I hadn't thought of that yet as our tax liability has higher than $2000 for many years

I really like doing taxes on paper and then transferring them to the Free Fillable Forms, but maybe I should use some free tax software for 2021 to be able to run various cases more efficiently.
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