It sounds too good to be true: Some workers can get a double tax benefit by saving for retirement. But the federal Saver’s Credit does just that by providing a second layer of tax incentives for lower-income households beyond the benefit of tax deferral that everyone receives for contributing to a 401(k) or IRA.
The Saver's Credit can be worth up to half of what you contribute to a traditional individual retirement account (IRA), Roth or workplace retirement plan. Yet only 25 percent of workers with annual household incomes below $50,000 know that it exists, according to research by the Transamerica Center for Retirement Studies (TCRS).
Chalk that up partly to the credit’s structure and usability - both of which need fixing. But it also stems from a lack of awareness. With tax season looming, here is a look at how the credit works, and how it could be improved.
The Saver's Credit provides a credit up to $1,000 ($2,000 for joint filers) for contributions to an IRA or workplace plan. For the 2015 tax year, it is available to joint filers with adjusted gross income up to $61,000. Single filers get the credit with income up to $30,500. Even if you did not contribute to a workplace plan last year, you can make a 2015 IRA contribution before April 18 to claim the credit.
Unlike a deduction, which reduces the amount of taxable income you claim, a credit is a dollar-for-dollar reduction of federal income tax liability. The amount of your Saver’s Credit can range from 10 percent to 50 percent, based on the amount you save, your income and your filing status. To determine your credit, see IRS Form 8880.
Barriers
Low awareness of the credit may stem in part from confusion among taxpayers. Although it is widely referred to as the Saver’s Credit, the Internal Revenue Service uses a more complicated-sounding name: the “Credit for Qualified Retirement Savings Contributions."
The credit can be claimed only on tax returns using forms 1040, 1040A or 1040NR. There is no opportunity to claim the credit on the 1040EZ. “There is some language about it in the instructions, but that’s about 20 pages long,” said Catherine Collinson, president of TCRS.
Another barrier: in order to take advantage of the credit, you need to have an income tax liability in the first place. According to the Tax Policy Center, 70 percent of households with incomes below $47,353 had no federal tax liability in 2014, using a broad definition of pretax income.
Many legislators and policy experts have urged strengthening the credit by making it refundable - in other words, available no matter what your tax liability. A bill introduced this month by U.S. Senator Ron Wyden, an Oregon Democrat, would create a refundable credit that would be deposited directly into a taxpayer’s IRA or myRA account. That would make the credit something more akin to an employer match and could help lower-income households accelerate their retirement saving. Wyden’s bill also would index the credit for inflation and raise slightly the income eligibility ceiling.