Barbara O’Neill, Ph.D., CFP® Extension Specialist in Financial Resource Management Rutgers Cooperative Extension
The retirement savings tax credit (commonly called the Saver’s Credit) for contributions to retirement savings plans (IRAs and tax-deferred employer savings plans) is a tool for building wealth. Even if the amount saved is relatively small, any amount of money placed in a retirement savings account is better than none. This is especially true when the savings deposit is offset by a reduction in income taxes. Taxpayers can qualify for a Saver’s Credit of up to $1,000 ($2,000 if filing jointly) for contributions made to an IRA through April 15 of the following calendar year (e.g., April 15, 2014 for 2013 income taxes). Effectively, this is a subsidy of their savings deposit by the federal government. Unfortunately, many people are unaware that this Saver’s Credit exists. Financial publications often don’t discuss it because their readership base earns too much money to qualify for this tax benefit. Designed for low- and moderate-income households the Saver’s Credit, like all tax credits, is a subtracted directly from the amount that a taxpayer owes. For example, if someone owes $3,000 in taxes and receives a $1,000 tax credit, only $2,000 is owed. Tax credits are, thus, much more valuable than tax deductions, which are based upon someone’s marginal tax bracket. For example, $16,000 of itemized tax deductions would save a taxpayer in the 25% tax bracket $4,000 in taxes ($16,000 x .25). The federal income tax credit for contributions to retirement savings plans (IRAs and employer plans) is a good incentive to save for the future. A 50% tax credit is available to single taxpayers with an adjusted gross income (AGI) of $17,750 or less and couples earning $35,500 or less (2013 figures). Tax credits of 20% and 10% are available to those with higher incomes up to specified annual limits. Visit the IRS website for more information. The tax credit for the AGIs listed above is 50% of the amount contributed, up to $2,000. That means that the highest tax credit you can earn is $1,000, if you contribute $2,000 to a retirement savings plan. This is in addition to other deductions allowed for the amount of the contribution itself. Retirement savings tax credits, at various percentages, are available to single taxpayers earning up to $29,500 and couples with an AGI up to $59,000 (2013 figures). Adjusted gross income (AGI) is gross income minus certain allowable expenses such as alimony and allowable contributions to a SEP or traditional IRA. It is important to remember that retirement plan contributions do not have to be made all at once. Instead, you can save the money gradually as you earn it. For employer retirement plans, such as 401(k)s, you tell your employer how much to set aside from each paycheck. For example, you might contribute 1 percent of your pay ($150 if you earn $15,000) and gradually increase the percentage of pay saved over time. For IRAs, you can make deposits when you meet the minimum amount required by a specific retirement plan. For example, if a bank or mutual fund requires $250 for IRA deposits, you could make four $250 deposits, totaling $1,000, over the course of a year. In summary, the Saver’s credit amount is based upon a taxpayer’s filing status, adjusted gross income, tax liability, and the amount contributed to qualifying retirement programs. Form 8880 is used to claim the Saver’s Credit, and its instructions provide details on figuring the credit correctly. Small steps matter! Even small amounts of money can grow to significant sums, especially in a tax-deferred investment with a federal income tax credit to offset the cost.