- The retirement contribution savings credit offers a rare triple tax benefit: it not only reduces taxes due dollar for dollar, the credit motivates you towards reducing your taxable income and saving in tax-advantaged retirement accounts.
- The credit benefit amount is calculated as a % of contribution to a qualified retirement account, such as a 401k or IRA, up to $1,000 for individuals and $2,000 for married couples filing jointly.
- Qualification requirements include income limits, and funding your retirement contribution by the deadlines.
When Uncle Sam offers you a gift in the form of a reduction in your taxes, you take it! With the tax deadline approaching, smart Americans are turning over every opportunity to save on their taxes as allowable by the IRS. Among those opportunities is the retirement savings contribution credit that can lower the tax bill of low- to medium-income individuals and couples who contribute to their retirement savings plans.
The Advantages of Tax Credits
First, what’s the difference between a tax deduction and a tax credit? While both lower your taxes, tax deductions only reduce taxable income whereas credits reduce your taxes owed dollar for dollar. Tax deductions such as contributions to retirement or health savings accounts, charitable donations, health care payments, or interest on home mortgages are deducted from your year’s income, lowering the figure used to calculate your taxes. Tax credits on the other hand are subtracted from the already calculated taxes, which make credits more impactful than deductions when it comes to reducing your tax liability.
And the retirement savings contribution credit can deliver a rare triple tax benefit if you qualify. Because it’s a credit designed to encourage you to save for retirement, the first benefit comes in the form of the deduction to your taxable income if you choose to save in a traditional IRA or 401k. Next come the tax advantages on the growth of your traditional retirement plan, tax-deferred if a traditional retirement plan or tax-free if you choose a Roth plan. Finally, the credit reduces your tax bill, dollar for dollar, for the year of your retirement savings contribution.
Read on to see if you qualify for this valuable credit, and what you have to do to receive it.
The Retirement Savings Contribution Credit
Americans have had to take on the responsibility of saving for their own retirement as guaranteed incomes and pensions have become less popular over the decades. Retirement accounts like company sponsored 401(k)s and Individual Retirement Accounts have become crucial now more than ever when it comes to meeting your financial needs in retirement.
If you’ve prioritized saving for retirement with your 401k or IRA contributions, this credit is your reward in the form of cash back in your pocket by lowering your tax bill.
The credit is for individuals with adjusted gross income (line 8b on the IRS Form 1040) of less than $32,000, or for married couples filing jointly with an AGI of less than $64,000. The income limit is $48,000 for head of household filing status.
While saving for retirement might be challenging at these income levels, the retirement contributions savings credit might just motivate you to find a way to put money aside in your employer’s 401k, 403b or 457 plan. If you’re saving in your own accounts, your contributions to your traditional IRA or Roth IRA. If you are self-employed, contributions to your SIMPLE IRA or SEP-IRA also qualify. Rollover transfers from your employer plan to an IRA, however, do not qualify for the credit.
If your income exceeds these limits, then you’re not eligible for this tax credit. Income taxpayers who are under age 18 or claimed as a dependent on someone else’s tax return are also disqualified. The saver also cannot be enrolled as a full-time student for five or more months during the calendar year, including enrollment at technical, trade, mechanical or online schools.
How the Saver’s Credit is Calculated
The credit is calculated as a percentage of your contribution amount to your retirement plan, up to a maximum credit of $1,000 for individuals and $2,000 for married filing jointly. The credit rate percentage used—10%, 20% or 50%— is based on the adjusted gross income reported on line 8 of your tax return. The IRS provides details in Form 8880, including this table that exhibits how the percentage decreases as the saver’s income increases.
|Credit Rate||Single||Head of Household||Married Filing Jointly|
|50%||$19,250 or less||$28,875 or less||$38,500 or less|
Let’s use Tim as an example. Tim works as a teaching assistant at a public school where he started in the middle of the year. He reports an annual income of $22,000 for 2019 (he worked just a portion of the year). A committed saver, he participates in his school’s 457 plan and contributes $2,500 for 2019. As a tax-deferred contribution, his adjusted gross income drops to $19,500. Based on the table above, his credit calculation will be 20% of $2,500 or $500.
But let’s say Tim is aware of the retirement savings contribution credit and decides to go for the maximum percentage allowed of 50%. He gives up expensive purchases and sells a few things towards the end of the year, and increases his retirement contribution to $3,000 (instead of $2,500), dropping his adjusted gross income even further. Now his AGI is $19,000 which qualifies him for the 50% credit rate. Applied to his contribution to his school’s 457 plan, his tax credit calculation comes to $1,500 ($3,000 times 50%), but this exceeds the credit allowable for individuals. His savings credit is therefore $1,000 which can be applied dollar for dollar against any income taxes he owes.
With the awareness of the retirement savings credit, you can determine whether it might be worth increasing your retirement contribution to qualify for a higher percentage and therefore receive a higher credit. Of course any amount of tax savings is good! Note, however, that the retirement contribution savings credit is not a refundable credit. This means you must owe taxes on which the credit is applied. Any unused credit is not refunded to you.
Don’t Miss Out on Tax Savings
You’re armed with the knowledge of tax credits and how your retirement contributions can provide you with meaningful tax savings. Be sure to fund your retirement accounts by the required deadline for the tax year. For your employer plans such as the 401k, the deadline is usually December 31. For Individual Retirement Accounts such as traditional IRAs and Roth IRAs, your deadline is April 15 the following year. Attach the required Form 880 to your final tax return.
The retirement savings contribution credit is Uncle Sam’s way of rewarding you for your retirement planning. Carving out a portion of your budget for savings and retirement is a smart and healthy financial habit to develop. This tax credit may be just the bonus that adds to your sense of accomplishment this tax season. Savor that feeling of success!