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.
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.
Next year’s new Congress should consider these ideas as part of a broader set of retirement policy reforms. For example, access to workplace retirement accounts could be achieved by creating Multiple Employer Plans (MEPs) -- an idea that has been proposed by Republicans and is included in President Barack Obama’s 2017 budget. At the same time, expansion of Social Security benefits should be on the table, especially for lower-income retirees.
“We strongly support expanding the saver’s credit by increasing the income thresholds and making it refundable,” said David Certner, legislative policy director at AARP. “It’s an important part of the mix along with some of the other retirement incentives pending in Congress -- whether they are enacted this year or next in the larger context of tax reform.”
Using the Credit
If you have not made a contribution to an IRA or myRA for 2015, you have until April 18 to do so (the usual April 15 deadline for tax returns has been pushed back by three days this year due to various state holidays on the 15th).
Most workers eligible for the Saver’s Credit also can take advantage of the IRS Free File program, which makes tax preparation programs from 13 software companies available free of charge. This is available to taxpayers with adjusted gross income of $62,000 or less.