The Best Retirement Tax Credit You Never Knew Existed

Eric McWhinnie for Wall St Cheat Sheet writes:  The retirement crisis in America is far from being solved. Workers are increasingly responsible for their own retirement savings, but are faced with a seemingly endless supply of obstacles. Households are experiencing stagnant wage growth, rising living expenses, and an overall weak labor market. Making matters worse, millions of people lack financial knowledge and often overlook ways to help them reach their retirement goals.

Benjamin Franklin once said that, “An investment in knowledge pays the best interest.” A large portion of the nation should heed this wisdom and learn about the Internal Revenue Service’s Retirement Savings Contributions Credit, also known as the Saver’s Credit. This overlooked credit is available to low and moderate income workers saving for retirement, but only 23 percent of Americans with annual household incomes of less than $50,000 are aware of the credit, according to the 14th Annual Transamerica Retirement Survey.

“The Saver’s Credit reduces an eligible taxpayer’s federal income taxes dollar for dollar, making it a meaningful incentive for low- to moderate-income individuals and households to save for retirement in a 401(k), 403(b), or IRA. Unfortunately, many may be missing out simply because they are unaware of it,” said Catherine Collinson, president of nonprofit Transamerica Center for Retirement Studies. “It’s critical that we raise awareness of this important tax credit and opportunity to save for retirement so that more workers can take advantage of it and improve their retirement outlook.”

The credit may be applied to the first $2,000 ($4,000 if married filing jointly) of voluntary contributions an eligible worker makes to a 401(k), 403(b), or similar employer-sponsored retirement plan, or an IRA. In order to qualify, you must be age 18 or older, not a full-time student, and not be claimed as a dependent on another person’s return. As the chart below shows, the Saver’s Credit is worth a percentage of your contribution, and adjusted gross income limits do apply — the less you make, the greater the percentage.

It’s important for workers to stay updated on the income limits. As the chart below shows, there are minor improvements for 2014. Also, rollover contributions are not eligible for the credit, and your eligible contributions may be reduced by any recent distributions you received from a retirement plan or IRA. However, the credit is a benefit in addition to other advantages such as tax deductions on retirement accounts.

The IRS provides the following example of the Saver’s Credit: “Jill, who works at a retail store, is married and earned $30,000 in 2013. Jill’s husband was unemployed in 2013 and didn’t have any earnings. Jill contributed $1,000 to her IRA in 2013. After deducting her IRA contribution, the adjusted gross income shown on her joint return is $29,000. Jill may claim a 50 percent credit, $500, for her $1,000 IRA contribution.” That’s a 50 percent return for just making the contribution to her IRA. Workers need to use Form 1040, 1040A, or 1040NR to file their taxes with the credit, which is detailed on Form 8880.

In 2012, more than 57 million households were eligible for the Saver’s Credit, but less than one fifth actually took advantage of it. While households eligible for the tax credit may find it difficult or nearly impossible to save for retirement, the responsibility ultimately falls on individuals. Nobody cares about your money and future as much as you do. The earlier you start making sacrifices and placing money aside for retirement, the better off you will be.