The saver’s credit helps eligible taxpayers offset the cost of saving for retirement. Now, low and moderate income workers can take steps to save for retirement and earn a special tax credit.
What is the saver’s credit?
The saver’s credit is a tax credit worth up to $1000 ($2,000 if married filing jointly). The saver’s credit is also called a retirement savings credit. The value of the saver’s credit is calculated based on your contributions to a retirement plan. This would include the traditional or Roth IRA, 401(k), SIMPLE IRA, SARSEP, 403(b) or 457(b) plan. The saver’s credit is available in addition to any other tax savings that apply as a result of contributing to retirement plans.
Saver’s credits rates for 2020 – 2021
Like other tax credits, the saver’s credit can increase a taxpayer’s refund or reduce the tax owed. The maximum saver’s credit is $1,000. However, taxpayers are cautioned that it is often much less. And, due to the impact of other deductions and credits, and may be zero for some taxpayers. (Note, the credit is $2,000 for married couples if both spouses contribute to a plan.)
What is the saver’s credit worth?
The amount of a taxpayer’s saver’s credit is based on the following:
- his or her filing status
- adjusted gross income
- tax liability
- amount contributed to qualifying retirement programs
How to calculate the saver’s credit value.
Eric and Heather file a joint return as a married couple. In 2020, Eric contributed $3,000 through his 401(k) plan at work. Heather contributed $500 to her IRA account. Their modified AGI for 2020 was $40,000. The credit’s value is computed as follows:
| Eric’s 401(k) contribution was $3,000, but only the first $2,000 can be used | $2,000 |
| Heather’s IRA contribution was $500, so it can all be used | $500 |
| Total qualifying contributions | $2,500 |
| Credit percentage for a joint return with AGI of $40,000 from the table | X.20 |
| Credit percentage for a joint return with AGI of $40,000 from the table Saver’s credit | $500 |
This example illustrates how the credit phases out for higher-AGI taxpayers. In this example, the couple’s AGI of $40,000 limits the credit to 20% of their qualifying contributions. Had their AGI been $39,500 or less, their credit percentage would have been 50% of their qualified contributions. This would net them a credit of $1,250.
The saver’s credit supplements the other tax benefits available to people who set money aside for retirement. Except for Roth IRA contributions, workers’ contributions to retirement plans are generally tax deductible. So, in addition to the saver’s credit, contributions to retirement plans provide a tax deduction for traditional IRAs or income reductions for certain other plans. This in turn, lowers the tax owed before the credit is applied. The credit itself can only be used to reduce taxes (income and alternative minimum taxes only) to zero. Any amount in excess of a taxpayer’s tax liability is lost.
Who can claim the saver’s credit?
- Eligible taxpayers must be at least 18 years of age.
- Anyone claimed as a dependent on someone else’s return cannot take the credit.
- A full-time student cannot take the credit.
The credit exists to encourage taxpayers to save for retirement. But the IRS has set up safeguards to prevent taxpayers from taking distributions from existing retirement savings and re-depositing them to claim the credit. For example, qualifying retirement contributions used to figure the credit are reduced by any retirement plan distributions taken during a “testing period”. The testing period includes the prior two tax years, the current year, and the subsequent tax year before the due date (including extensions) for filing the taxpayer’s return for the tax year of the credit.
As you can see, qualifying for and using this credit involves following a complicated set of rules, but the credit can be very beneficial. If you are not sure you can afford to fund your retirement plan, contributions to an IRA or a self-employed retirement plan (SEP) can be made after the close of the year. This way you can determine the tax benefit of the saver’s credit and your overall tax refund before contributing to a plan. For example, IRA contributions for 2020 can be made up to April 15, 2021, while SEP contributions can be made until October 15, 2021 if your return is on extension.
If you have questions about how this tax benefit might apply in your situation, please give this office a call at 360-778-2901.
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