The U.S. Tax Code encourages certain behaviors. You can save on taxes by getting married and having children. It does this by offering certain incentives in the form of tax breaks, deductions, and credits targeted at these areas.
Saving for retirement in recognized ways can also generate a tax credit, albeit a nonrefundable one. Nonrefundable credits reduce your tax liability dollar for dollar, but if the credit exceeds your tax liability, the excess is lost. It cannot be carried back or forward to other tax years. For example, if your tax liability is $750 and your credit is $1,000, the allowable credit is the $750 needed to reduce your tax liability to zero.
Here’s everything you need to know about the Retirement Savings Contribution Credit. For help with other issues, check out our complete Tax Guide.
Credit Requirements and Income Limitations
If you make eligible contributions to qualified retirement plans, deferred compensation plans, or an individual retirement arrangement (IRA), you may be able to claim a credit known as the Retirement Savings Contributions Credit, commonly called the Saver’s Credit. See Chapter 3 of Publication 590-A for details from the IRS.
Eligible contributions are those made to the following plans:
- Traditional or Roth IRA
- 401(k), including SIMPLE 401(k)
- Section 403(b) annuity
- Governmental 457 plan
- SIMPLE IRA plan (Savings Incentive Match Plan for Employees)
- Salary reduction SEP plan (Simplified Employee Pension)
- Section 501(c)(18) plan (a trust created before June 25, 1959, forming part of a plan to pay benefits under a pension plan)
Besides making eligible contributions, you must also:
- Be age 18 or older
- Not be a full-time student
- Not be claimed as an exemption on someone else’s return
- $30,750 if filing Single, Married Filing Separate (MFS) or Qualifying Widow(er),
- $46,125 if filing Head of Household, or
- $61,500 if filing Married Filing Joint (MFJ).
Credit Amount and How to Claim it
The credit is figured on Form 8880 and is reported on Form 1040, line 51. Distributions from qualified plans or IRAs from 2014 through the 2016 filing date must be subtracted from current tax year contributions (2016 in this example) to figure eligible contributions. The maximum eligible contribution for the credit is $2,000 per person.
The amount of the credit is based on your contributions, your filing status, and your credit rate. The credit rate is between 10% and 50%, depending upon your filing status and your income. There is a table on Form 8880, that shows income brackets and the credit rate for each corresponding filing status.
For example, if your filing status is Single, MFS or Qualifying Widow(er), your credit rate is 50% if your income is not over $18,500. For Head of Household, the 50% credit rate applies if your income is not over $27,750. And, if you file Married Filing Joint, the credit rate of 50% applies if your income is under $37,000. Since the maximum contribution for the credit is $2,000, and the maximum credit rate is 50%, the maximum allowable credit is $1,000 ($2,000 if MFJ and both spouses made eligible contributions).
Saving for retirement is not easy, but it’s made more palatable by the Saver’s Credit. If you contribute $2,000 to a Traditional IRA, you may be able to take an adjustment that lowers your taxable income by $2,000. If you are in the 25% tax bracket, that could save you $500 in tax liability. Then, if you are eligible for the Saver’s Credit, that could lower your tax liability by $1,000.
So, in effect, you have an almost immediate return of $1,500 on a $2,000 investment. Where else can you invest $2,000 and get a 75% return? That is more than palatable – that is compelling. If you have children and happen to qualify for the Earned Income Tax Credit, your refund may increase by $2,000. You could fund your contribution from that refund, effectively making the contribution from free money.
If you get in the habit of “paying yourself first,” that is, contributing to your retirement plan as your top priority, your retirement fund will grow and be able to supplement your retirement income from pensions and Social Security.
For help with other issues, check out our complete Tax Guide.
Have you used this credit before? Which others would you recommend?