Numerous surveys confirm that a top concern many Americans have about retirement is whether they’ll have enough money to cover their expenses for potentially three decades. So at first glance, it’s a bit surprising that more people don’t take advantage of free money available from Uncle Sam via the “Retirement Savings Contributions Credit” or, as it’s commonly called, the Saver’s Credit.1
If you meet the requirements, married couples filing jointly may take a credit up to $2,000 against their federal income tax bill. The maximum credit for other filers is $1,000. (Note that a “credit” is different from a “deduction.” Once you compute your tax bill, a credit is subtracted from the amount you owe. In other words, it reduces your tax bill dollar for dollar, potentially down to $0. If your saver’s credit is larger than your tax bill, you do not get a refund of the excess.)2
How It Works
If you’re living on a limited income, it can be tough to make ends meet, much less think about setting money aside for retirement. That’s where the Saver’s Credit comes in. In a sense, it’s a reward, a gold star, for those who manage to accomplish this.
To qualify, you have to meet the income requirement: If you’re married and file a joint return, your adjusted gross income (AGI) can’t be more than $62,000 for 2017. The limit for other filers, as shown below, is half that—$31,000.
2017 Saver’s Credit Tables
Quoting from the IRS, ”the amount of the credit is 50%, 20% or 10% of your retirement plan or IRA contributions up to $2,000 ($4,000 if married filing jointly), depending on your adjusted gross income.” The IRS chart below can help calculate your credit.
Wait! Before you click to another article thinking, “Well, this certainly doesn’t apply to me—my income is much higher than that,” stop and consider whether you know someone who does qualify. Perhaps your daughter who just started her first full-time job out of college last summer or maybe a semi-retired parent who works part-time.
Let’s say your daughter began working in her first “real” job last June, the month after college graduation. Her annual salary is $24,000, but since she only worked seven months in 2016, her AGI will be less than $18,500. Assuming she signed up for her company’s 401(k) plan, did she contribute at least $2,000? If the answer is yes, she qualifies for a $1,000 tax credit!
If she didn’t contribute that much, there is still time to fund an individual retirement account (IRA) by this year’s April 18 tax filing deadline. Her credit will be based on the total amount she contributed to both retirement plans. (Note: For single filers, the credit only applies to up to $2,000 in retirement contributions. If you file a joint return, the maximum contribution that applies is twice this amount—$4,000.)
How about that part-time job your 64-year-old father has at the big box home and garden center? He might not work enough hours to qualify for the company retirement plan, but because he has earned income, he can contribute to an IRA.
Let’s assume your parents’ 2016 adjusted gross income is at least $37,001 but not more than $40,000. This means they qualify for a 20% credit. If your dad makes a $4,000 contribution to an IRA, he and mom get to subtract $800 from their 2016 federal income tax bill, if they file jointly.3
Any Retirement Plan Will Suffice
As the previous examples suggest, contributions toward the Saver’s Credit can be made to any legitimate retirement account: 401(k), 403(b), traditional IRA, Roth IRA , Keogh plan, simplified employee pension plan (SEP), savings incentive match plan for employees (SIMPLE) IRA, etc.
Not for Everyone
Before you get too excited about the Saver’s Credit, you need to know that in addition to meeting the income requirements, you also must meet the following criteria for the relevant tax year:
- Were at least age 18
- Were not a full-time student, and
- Are not being claimed as a dependent on someone else’s tax return
In other words, while your newly graduated daughter might qualify, her 20-year old brother, who’s a sophomore in college and is being supported by you and your spouse, probably doesn’t—even though he had a summer job.
It Adds Up
While the tax savings is nice, it’s really just the incentive for the more important goal: encouraging Americans to save for retirement. Assuming annual returns of 6% per year, the $2,000 IRA contribution of your 22-year-old daughter can grow more than ten-fold by the time she’s 62—to $20,571.
If your parents already have a pretty low income-tax bill, your father could opt to make a contribution to a Roth IRA. Again, assuming an annual return of 6%, by the time he’s 84, your parents will be sitting on a $12,829 nest egg that is completely tax-free. And, if mom and dad don’t spend it by the time they pass away, it can pass tax-free to their beneficiary.
Come to think of it, that could be you!
Learn more about developing a strategy to fund your own retirement: www.franklintempleton.com/whatsnext.
Gail Buckner’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Opinions and analyses are rendered as of the date of the posting and may change without notice.
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