With all of the various financial priorities taking up our time and money, saving for retirement is something that we often put off for “later”. We figure that sometime in the future we’ll have more money, more knowledge, more something that will let us handle that retirement need.
It’s an understandable mindset, though an unfortunate one given how powerful it can be to start saving for retirement early. But with all of our financial responsibilities, it can sometimes be hard to find the extra cash to put towards something that might be decades in the future.
But what if there was a way to make saving for retirement a little more affordable? What if we could actually get some of the money we put away for retirement back in the form of cold, hard cash?
Well you can. It’s a little known tax credit called the saver’s credit and it can be a huge financial boon for the people who can use it.
What is the saver’s credit?
Officially known as the “retirement savings contributions credit”, the saver’s credit allows certain people to take a tax credit against some of the money they contribute to their retirement accounts.
Essentially, it makes it less expensive to save for retirement for people who qualify.
For 2014, the maximum tax credit for married couples who file jointly is $2,000. That means that you could potentially save $2,000 in taxes by qualifying for this credit. That’s money that goes right back into your pocket.
For single parents, whether you file your taxes as single or head of household, the maximum credit is $1,000.
How does it work?
First, you have to have contributed money during the year to an eligible retirement account. According to this link from the IRS, eligible retirement accounts include:
- Traditional IRA
- Roth IRA
- SIMPLE IRA
- Other voluntary after-tax contributions to a qualified retirement and 403(b) plans
Please note that rollovers are NOT eligible. Only new contributions.
The amount of your saver’s credit is then calculated as a percentage of your eligible retirement contributions. The percentage depends on your tax filing status and your AGI. Your AGI (adjusted gross income) is your earned income with certain deductions taken out. I’ll explain a little bit more about it below.
Here’s a table showing what percent of your contribution you can claim as a credit for different filing statuses and levels of AGI for the 2014 tax year:
So as a quick example, let’s say that you and your spouse are married filing jointly and have an AGI of $50,000. If you both make $2,000 retirement contributions, you would each get to take 10% of that as a tax credit, which amounts to $400 total.
Keep in mind that:
- The credit is calculated per individual, so you would EACH need to make contributions to your own accounts in order to get the maximum total credit.
- Any contributions over that $2,000 per person would not qualify for an additional credit (though they would still be incredibly worthwhile!).
What is AGI?
AGI stands for Adjusted Gross Income, which is just a fancy way of saying that you start with your full income and subtract certain items. The result is a smaller amount of income, your AGI, and that number is used to determine whether you qualify for a number of other deductions and credits. Including the saver’s credit.
So what items are deducted from your gross income to arrive at your AGI? You can see a more expansive list here, but some of the more common items include:
- Tax-deductible contributions to a retirement account (such as a traditional 401(k) or IRA. Roth contributions are non-deductible.)
- Contributions to a health savings account
- Student loan interest
- Tuition and fees
- Moving expenses
- Self-employment taxes
- Self-employment health insurance
Take a look at that first item on the list. Tax-deductible contributions to a retirement account will lower your AGI, which in turn will make it more likely for you to qualify for the saver’s credit. That’s potentially money in your pocket from the deduction PLUS money in your pocket from the credit. Talk about a double win!
This is just a little more potential fuel to the Traditional fire in the Traditional vs. Roth IRA debate, since a Traditional IRA may help you qualify for the credit while a Roth IRA will not. That is, contributions to either are eligible for the credit, but only the Traditional will lower your AGI, which may be helpful in making YOU eligible for the credit.
Let’s look at a quick example of what I’m talking about.
Let’s say a married couple has an AGI of $42,000 before any retirement contributions. They’re debating whether to put $4,000 into a Roth IRA vs. $4,000 into a Traditional IRA. There are many other considerations that should go into this decision, but right now we’ll look at it purely from the perspective of the saver’s credit.
If they choose a Roth IRA, their AGI will stay at $42,000 and using the chart above they will qualify for a saver’s credit of 10% of their contribution. So at tax time they will be able to claim a credit of $400.
But if they choose a Traditional IRA, they will lower their AGI to $38,000. Now they will qualify for a saver’s credit of 20% of their contribution and will get back $800 at tax time.
Again, there are many other things to consider when making the decision between a Traditional and Roth IRA, but this is certainly one to keep in mind.
Some quick notes about the saver’s credit
The saver’s credit is non-refundable, meaning the most it can do is reduce your tax liability to $0. Some tax credits can actually cause the government to pay you money, but this is not the case with the saver’s credit. What this means is that there might be some circumstances where you qualify for the credit, but because of other credits and deductions you don’t actually have enough tax liability to use it.
Any distributions from your retirement accounts over the year can reduce the credit you are eligible for.
For some more information, you can check out this summary from the IRS.
If you can take advantage of the saver’s credit, you can put money away for tomorrow while putting money in your pocket today.
Who doesn’t like the sound of that?
Disclaimer: The information above is accurate, but I am not a CPA and cannot make any recommendations for your specific situation. Please consult a qualified tax professional before making any personal tax decisions.