Millions of Americans sock away money into retirement plans, such as 401(k)s and IRAs. And the IRS lets most workers exclude those contributions from taxable income. For example, if you deposit $1,000 in your IRA, you won’t pay income tax on that amount.
Another benefit is that the money grows tax-free until you withdraw it, presumably during retirement when you’ll be in a lower tax bracket.
But maybe you’re already in a low tax bracket, so you’re thinking: why bother? Or you assume that with a $20 trillion deficit that continues to swell, tax rates will be higher when you retire. Or perhaps Washington will completely do away with the tax benefits that come with retirement accounts.
All good points that make planning for the longer term a challenge.
However, the IRS is eager to hand you an upfront reward if you make those contributions … a reward in the form of a tax credit.
A tax credit is an immediate direct reduction in the amount of tax you owe. So it’s a better deal than a tax deduction, which only reduces taxable income.
The Retirement Savings Contributions Credit, or Saver’s Credit, was enacted as part of EGTRRA (Economic Growth and Tax Relief Reconciliation Act) in 2001 and made permanent by the Pension Protection Act of 2006.
The credit is 50%, 20% or 10% of your retirement plan or IRA contributions, depending on your adjusted gross income (AGI). The lower your income, the larger the potential credits. And it can chop your tax bill by up to $2,000 ($4,000 if married filing jointly).
For an example of how this works, suppose you earned $37,000 in 2016. And your spouse didn’t have any earnings. If you contributed $1,000 to your IRA, then your AGI would be $36,000. That means you could claim a 50% credit, $500, for your $1,000 IRA contribution.
If your income was $40,000, you’d get a 20% credit worth $200. And with a $60,000 income, a 10% credit would cut your tax bill by $100.
You get a tax deduction — and a tax credit to boot. It almost sounds too good to be true!
You’re eligible for the Saver’s Credit if you are:
At least 18 years old,
Not a full-time student, and
Not claimed as a dependent on another person’s tax return.
Retirees who have even a small amount of earned income might be in a good position to take advantage of the Saver’s Credit. Earned income includes wages, tips and earnings from a business you own.
Eligible retirement savings
Your contributions to a traditional or Roth IRA, 401(k), SIMPLE IRA, SARSEP, 403(b), 501(c)(18) or governmental 457(b) plan; and your voluntary after-tax employee contributions to your qualified retirement and 403(b) plans are eligible for the Saver’s Credit.
Contributions that you moved from another retirement plan or IRA are not eligible. And eligible contributions may be reduced by recent distributions you took from a retirement plan or IRA.
How to get the credit
Start by entering all of your retirement plan contributions on Form 8880, Credit for Qualified Retirement Savings Contributions.
You have plenty of time until the April 17, 2018, filing deadline to open a Roth or traditional IRA and contribute for the 2017 tax year to take advantage of the Saver’s Credit.
And even if you aren’t eligible for the full credit, look at it this way:
Every tax dollar that stays in your pocket instead of going to the IRS is one less dollar Washington can waste.
The Uncommon Wisdom Daily Team