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Credit for saving can mean more money in your wallet

If you have a modest income, you've probably been asking yourself how you will ever be able to find the money to start saving.

So here it is: Provided your income is low enough, the federal government will pay you to stash money away for your retirement — giving you as much as $1,000.

The deal comes through what's known as the "saver's credit." You can find it buried in the tax return you do each year, and if you use the free tax preparation software the government gives people with incomes below $58,000, locating the saver's credit will be fairly easy. The "Free File" software is available at IRS.gov.

I suggest using the software, because paper forms make finding and using the saver's credit more difficult than finding Waldo on a book page. Even finding the name in tax materials will be perplexing, because the government uses two other names for the saver's credit. On the 1040 form, look for "Retirement Savings Contribution Credit," and on Form 8880, look for "Credit for Qualified Retirement Savings Contributions," said Catherine Collinson, president of Transamerica Center for Retirement Studies. You won't find the saver's credit on the 1040EZ form.

Hunting for this credit is worth the extra effort. Just ask yourself: If I told you that you could find a couple of hundred dollars by searching under all the furniture cushions in your home, would you do it?

The saver's credit is available to individuals with incomes less than $29,500 and couples with incomes less than $59,000, and the benefit depends on your income. Go to http://1.usa.gov/1dkeGik. The typical credit is about $200 for couples and about $122 for individuals. To qualify, you have to save for retirement either through a 401(k) or similar retirement savings plan at work, or through a new or existing individual retirement account.

Although you might think saving is impossible given your bills, the found money may make it possible. Consider a nurse whom Texas certified public accountant and financial planner Jerry Love advised. With an income of almost $32,000, she would have thought the saver's credit was outside her reach. But Love had her put $2,500 into an IRA, where she will save for her retirement years from now on.

By reporting on her tax return that she was putting $2,500 into an IRA, she got a deduction that brought her income just below the $29,500 maximum allowed for the saver's credit. Immediately, that cut her taxes by $375. Then she got a saver's credit of $250.

In other words, the government gives her $625 to save for her future. So she can save a total of $2,500 for retirement but needs to come up with only $1,875 out of pocket.

When people don't have the full $2,500, or some lesser amount, available to deposit immediately in an IRA, they use tax filing deadlines to their advantage. They report on their taxes what they will deposit in an IRA, then file their taxes long before the April 15 deadline for IRA contributions. When the tax refund arrives, they use that money to fund their IRA fully — just as they reported on their tax return — by April 15.

You don't have to put $2,500 into an IRA. Even $50 would do at a brokerage firm such as Scottrade or Charles Schwab. Low-cost mutual fund companies such as T. Rowe Price typically require $1,000 or more to get started with an IRA.

The nurse in Love's example put in $2,500 so she could get her income down to the level needed to get the saver's credit. If she retires in 40 years, the $1,875 she took out of her pocket, plus the money from the government, will end up giving her about $54,000 for retirement.

And if she stashed another $2,500 a year into the IRA for the next 40 years, she could end up with almost $700,000. I'm assuming she invests in what's known as a "balanced fund," or a mutual fund that divides your money roughly half and half in stocks and bonds.

The possibilities get even sweeter if you have a 401(k) at work and an employer that will match 3 percent of your pay if you also contribute at least 3 percent of your own money. Consider the nurse who was willing to contribute $2,500 and had an income of about $32,000. In this case, she would get $625 in tax reductions from the government and $960 in free matching money from her employer.

Said Love: "Your $2,500 gives you almost $1,600 of immediate benefit."

Gail MarksJarvis is a personal finance columnist for the Chicago Tribune.