Saving up for retirement is clearly a challenge for lower-income workers. Often struggling just to make ends meet, few of these families and individuals are setting aside significant assets to adequately supplement their Social Security retirement benefits once they receive their gold watch. But a little-known tax credit is available to taxpayers below certain income thresholds that can pick up as much as half the cost of a retirement plan contribution.
Numerous studies have indicated that only about half of all American private sector workers participate in a retirement savings plan at work. This is alarming enough and adumbrates a looming crisis as the baby boomer generation retires in larger numbers. But unsurprisingly, the majority of those with little or no savings in an IRA or 401K are low-income workers who lack access to a plan at work or feel they cannot afford to reduce current income to sock away funds for their golden years.
Enter the saver's credit. This provision allows taxpayers to claim a tax credit that reimburses up to 50 percent of the first $2,000 contribution to a qualified retirement plan, subject to certain restrictions and income limits. It is important to note that this is not a deduction from income but a direct credit applied dollar for dollar after your tax is computed. And the credit is refundable, which means you could get a check from the IRS if the credit exceeds your tax liability.
The maximum credit of 50 percent up to $1,000 is available to single filers earning $18,000 or less, or to each spouse for a married couple filing jointly with income of $30,000. The amount of the maximum credit declines with increasing income up to $30,000 for single filers or joint income of $60,000.
The saver's credit, known formally as the retirement savings contribution credit, is available for contributions to a broad array of savings vehicles including IRA, 401(k), and 403(b) accounts. For most taxpayers, contributions to one of these plans are tax deductible, reducing the current year's taxable income and tax liability. In addition, for low- to moderate- income filers, the saver's credit is added on after any other deductions, creating a tremendous incentive to start participating or to boost current contributions to take advantage of the credit.
The deadline for contributions to company-sponsored plans like 401(k) plans is Dec. 31, so deferrals made this year will be eligible for the credit on next year's taxes. But IRA contributions may be made up until the tax filing deadline of April 15 and still qualify for this year's credit on your 2014 tax return.
Roth IRAs, while not deductible against current income, allow for tax-free distributions in retirement and may be an excellent choice for younger, moderate- income workers in lower tax brackets with many years ahead for growth. The saver's credit is also available for Roth IRAs, making the deal even sweeter.
Some other restrictions apply. You must be at least 18 years old, and cannot be claimed on another person's tax return as a dependent. And full-time students are ineligible for the credit (but will be soon enough).
The saver's credit was first enacted as a temporary measure included in the 2002 tax cut legislation but was made permanent in 2006. Still, the generous provision is relatively unknown and should receive more attention. Where else can you generate an immediate 50 percent return and then watch it compound tax deferred until you retire? If you are eligible for this credit, make every effort to take advantage.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co. in Chattanooga.