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By Jason Lina / AdviceIQ
July 22, 2015

Over your career, you will probably face a year or more with limited income. Believe it or not, these situations present powerful savings opportunities, generally only for a limited time. Here’s what to know to take advantage, especially regarding your taxes.

The tax tips below are several of the most common opportunities if you find yourself off to graduate school or taking time out of the labor market (voluntarily or otherwise).

Exploit the Roth. A Roth individual retirement account is generally a powerful long-term financial opportunity in a year of unusually low income. Because of the tax-free growth, the economics of a Roth IRA contribution or conversion work best when you enjoy a long time for your investments to grow; a low tax rate at the time of the contribution or conversion; or potentially higher personal income tax rates in the future.

To qualify to make Roth contributions, you must earn income during the tax year that includes wages and salaries but not investment earnings. If you’re a student and depending on the financing costs, you might want to borrow an extra $5,500 from student loans for annual Roth contributions.

Roth conversions can be an even better opportunity if you hold existing IRAs or 401(k)s accounts from prior employment, creating taxable income you can offset using deductions and credits or that incurs tax at unusually low rates. Deductions and credits can sometimes allow you, if your income’s low enough, to convert assets to a Roth for free.

Sell your winners. Low-income years also present a unique opportunity to take advantage of the 0% capital gains rate. Taxpayers who use the filing status single and with taxable income below $37,450 and married taxpayers making less than $74,900 qualify for this rate.

If you still hold a stock that’s appreciated significantly since grandma gave you the shares years ago, consider selling it at 0% taxes. You can always buy back the stock later, simply increasing your cost basis (the price you originally pay for a stock).

Cash old Savings Bonds. If you received U.S. Treasury Savings Bonds (Series EE, E or I) as a child and still wonder what to do with them, lean years can mark a great time to cash them in.

In most cases, income on these bonds is not taxed until you redeem the bond or it matures. Realizing this income during a year when don’t make much is generally wise.

Research when the bonds were purchased, though, since it might make more sense to hold pre-1995 bonds due to rock-bottom interest rate at that time.

Retirement Savings Contributions Credit. This tax credit, rarely publicized because the qualifying income limits are relatively low, is a powerful opportunity. It essentially rewards you for contributing to your IRA or employer-sponsored retirement plan.

In some respects, the credit behaves like an employer-provided retirement plan match of some percentage of your savings – except here the Internal Revenue Service matches the funds. If you are married and have adjusted gross income (AGI) of less than $61,000 a year, you can qualify for the credit ($30,500 AGI for single filers).

Consider shifting dollars from a savings account to a Roth IRA: You qualify for the tax credit – as much as 50% of the IRA contribution – and you get funds into a Roth IRA.

This credit is unavailable to full-time students; a married couple with one spouse in school and the other working does qualify. You can also use it for your final year of graduate school if you earn income for some of the year of income and are no longer a full-time student at the end of the tax year.

The Earned Income Tax Credit (EITC). You must have limited employment income and less than $3,400 in investment income to claim the EITC, which also depends on the number of qualifying children you claim: $53,267 in 2015 for a married couple with three or more children. Taxpayers without qualifying children must be at least 25 years old; taxpayers with children face no minimum age requirement.

What can make the opportunity so valuable if you earn little: The EITC is refundable. This means that you can receive money from credit, which can be as much as a few thousand dollars, even if your income tax is zero.

Make sure you meet all qualifications before taking this credit.

Run expenses through a 529. These pre-payment plans were established to promote long-term saving for college, but state tax rules provide a loophole that encourages using these plans for short-term savings.

Of the 45 states with an income tax (including the District of Columbia), 35 offer tax deductions for 529 Plan contributions. Most of these states do not have a waiting period on withdrawals. You can funnel graduate school expenses through a 529 plan (even proceeds from a student loan), immediately distribute the funds from the plan and claim a state tax deduction up to the state limits.

If you live in such states as South Carolina and Colorado, where there is no limit on the deduction, or in states like New York with high income taxes, this strategy works well. You can’t claim any education tax credits, such as the Lifetime Learning Credit or American Opportunity Tax Credit, with the same dollars that you use for this 529 tactic, but as long as your graduate school costs exceed $10,000, you can employ the strategy.

Claim the Child Tax Credit. If your employment income falls below $75,000 and you file taxes using the single status ($110,000 if you file married filing jointly), you can claim the child tax credit to reduce income tax up to $1,000 per child. The less your income, the bigger the credit.

As with the EITC, you can receive money for the credit even if you owe no income tax.

Savings are great, of course, but always run the numbers or review the nuances of credits to understand what works best for you.

Jason Lina, CFA, CFP, is Lead Advisor at Resource Planning Group Ltd. in Atlanta.

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