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EQUITY Responds: WID Answers Your Questions
As part of a Weed & Seed strategy in my neighborhood, there is a Volunteer Income Tax Assistance (VITA) program. Last year, they were stressing the importance of “leveraging” the “EITC”. What does that mean? Isn’t leveraging something very risky?
The Earned Income Tax Credit (EITC) is a federal income tax credit for low-income workers. The credit reduces the amount of tax an individual owes, and may be returned in the form of a refund.
In this context, leveraging refers to a strategy to increase the value of the EITC to the recipient. The concept is usually best understood by using an example.
In 2006, the maximum EITC refund for a married couple earning $37,000 with two children is $4,400. Starting in 2007, the Internal Revenue Service allows tax payers to direct their refund into as many as three different accounts. Look at the following example of what can be achieved if, instead of spending $4,400 refund, the family directs it into three new, different accounts:
1. Fund a retirement account and qualify for the Retirement Savings Credit.
According to the Wood Stock Institute, the recently reworked Retirement Savings Credit provides low-income families an opportunity for retirement planning. This revised credit provides a 50 percent tax credit match for every dollar contributed to a retirement account.
Thus, if each spouse directed $1,500 of the EITC refund into a retirement account, for a total of $3,000, , the couple could receive in the same year an additional tax credit of $1,500.
Additional leveraged return: $1,500
2. Direct part of the refund to open and fund two Individual Development Accounts.
Most IDAs require that the participant make monthly contributions in order to receive the matching funds. Both spouses could use part of the EITC refund to contribute $50 each per month to an IDA account. If the program provided a three-to-one match, at the end of the year, each spouse would have accumulated $2,400 in their account. ($600 from individual contributions, with a match of $1800).
Additional leveraged return: $3,600 ($1,800 per spous)
3. Open a traditional savings account at a credit union or bank.
Many low income people do not have access to traditional banking services. Instead, they often rely on pay day lenders and check cashing services who charge enormous fees for their services. By directing the remainder of the EITC refund to open a traditional savings account, both spouses will benefit from lower fees and a safe place to save their money, and be able to build a relationship with a financial institution. According to the World Bank, moving from un-banked to banked status can save a lower income person up to 2.5-4% of their annual income.
Additional Leveraged return: 2.5-4% of annual income
As you can see, the additional value returned to the EITC recipient can quickly add up. When you consider that a tax payer can retroactively apply for the EITC going back three years, the leveraging opportunities increase even further.
The Earned Income Tax Credit (EITC) is a federal income tax credit for low-income workers. The credit reduces the amount of tax an individual owes, and may be returned in the form of a refund.
In this context, leveraging refers to a strategy to increase the value of the EITC to the recipient. The concept is usually best understood by using an example.
In 2006, the maximum EITC refund for a married couple earning $37,000 with two children is $4,400. Starting in 2007, the Internal Revenue Service allows tax payers to direct their refund into as many as three different accounts. Look at the following example of what can be achieved if, instead of spending $4,400 refund, the family directs it into three new, different accounts:
1. Fund a retirement account and qualify for the Retirement Savings Credit.
According to the Wood Stock Institute, the recently reworked Retirement Savings Credit provides low-income families an opportunity for retirement planning. This revised credit provides a 50 percent tax credit match for every dollar contributed to a retirement account.
Thus, if each spouse directed $1,500 of the EITC refund into a retirement account, for a total of $3,000, , the couple could receive in the same year an additional tax credit of $1,500.
Additional leveraged return: $1,500
2. Direct part of the refund to open and fund two Individual Development Accounts.
Most IDAs require that the participant make monthly contributions in order to receive the matching funds. Both spouses could use part of the EITC refund to contribute $50 each per month to an IDA account. If the program provided a three-to-one match, at the end of the year, each spouse would have accumulated $2,400 in their account. ($600 from individual contributions, with a match of $1800).
Additional leveraged return: $3,600 ($1,800 per spous)
3. Open a traditional savings account at a credit union or bank.
Many low income people do not have access to traditional banking services. Instead, they often rely on pay day lenders and check cashing services who charge enormous fees for their services. By directing the remainder of the EITC refund to open a traditional savings account, both spouses will benefit from lower fees and a safe place to save their money, and be able to build a relationship with a financial institution. According to the World Bank, moving from un-banked to banked status can save a lower income person up to 2.5-4% of their annual income.
Additional Leveraged return: 2.5-4% of annual income
As you can see, the additional value returned to the EITC recipient can quickly add up. When you consider that a tax payer can retroactively apply for the EITC going back three years, the leveraging opportunities increase even further.