The Saver's Tax Credit: An Added Incentive to Fund Your Plan

Let's face it: funding one's retirement plan is not always a priority, and many taxpayers may feel their income should go toward more immediate needs. However, there is an added incentive to save for retirement in the form of a non-refundable tax credit known as "the saver's tax credit" (or saver's credit). Because this credit is in addition to any tax deduction received for contributions made to a Traditional IRA, it helps to reduce the taxpayer's tax liability to the IRS.

Saver's Tax Credit Defined
The saver's credit is a non-refundable tax credit available to eligible taxpayers who make salary-deferral contributions to their employer sponsored 401(k), 403(b), SIMPLE, SEP or governmental 457 plan, and/or make contributions to their Traditional and/or Roth IRAs. The credit is between 10 to 50% of the individual's eligible contribution of up to $2,000, which means it cannot be more than $1,000 (see table below). Further, the maximum credit amount is the lesser of either $1,000 or the tax amount the eligible taxpayer would've had to pay without the credit. The saver's credit can be used to offset the individual's alternative minimum tax liability and/or regular income-tax liability. In the determination of the saver's credit amount, refundable credits and the adoption credit are not taken into consideration.

Eligible Taxpayers
In order to be eligible for the saver's credit, an individual must be at least 18 years old by the end of the applicable tax year. Individuals who are full-time students and who are claimed as a dependent on another taxpayer's return are not eligible for the saver's credit. The definition of a full-time student varies among schools. Therefore, individuals should check the school they attend to determine its definition of 'full-time.'

The other criterion for the credit is that the individual's adjusted gross income (AGI) must not exceed the following limits:

2008
Credit Rate	Married and files a joint return	Files as head of household	Other category of filers
50%	Up to $32,000	Up to $24,000	Up to $16,000
20%	$32,001 – $34,500	$24,001 – $25,875	$16,001 – $17,250
10%	$34,501 – $53,000	$25,876 – $39,750	$17,251 – $26,500
0%	$53,001+	$39,751+	$26,501+

2009
Credit Rate	Married and files a joint return	Files as head of household	Other category of filers
50%	Up to $33,000	Up to $24,750	Up to $16,500
20%	$33,001 – $36,000	$24,751 – $27,000	$16,501 – $18,000
10%	$36,001 – $55,500	$27,001 – $41,625	$18,001 – $27,750
0%	$55,501+	$41,626+	$27,751+

As you can see from the chart, the lower the individual's AGI, the higher the saver's credit, which helps increase the incentive for lower-income taxpayers to fund their retirement accounts.

Example Jane, whose tax-filing status is 'single', has an AGI of $16,500 for tax year 2009. Jane contributed $800 to her employer sponsored 401(k) plan and also contributed $600 to her Traditional IRA. Jane is therefore eligible for a non-refundable tax credit of $700 [($800 + $600 = $1,400 x 50%]. Had Jane's AGI exceeded $27,750, she would not be eligible for the credit.

Effect of the Saver's Credit
By contributing to a retirement plan and claiming the saver's tax credit, the taxpayer reduces the amount of income tax he/she owes to the IRS. To illustrate this point, the IRS has provided the following example and given employers permission to use it, along with other explanations in related communications to employees.

Example 2 Susan and John are married and file their federal income-tax return jointly. For 2009, their adjusted gross income would have been $34,000 if they had not made any retirement contributions. During 2009, Susan elected to have $2,000 contributed to her employer's 401(k) plan. John made a deductible contribution of $2,000 to an IRA for 2009. As a result of these contributions, their 2009 adjusted gross income is $30,000. If they had not made the $4,000 contribution, they income tax would have been about $4,260. By making the contribution, their income tax is reduced to about $3,660 and they are eligible for a credit of $800. Thus, by saving $4,000 for their retirement, Susan and John have also reduced their taxes by $1,400.

Return of Excess Contributions Not Eligible for Credit
An individual who contributes an amount in excess of the allowable limit is required to correct the excess contribution by removing the amount within certain time frames. This correction is referred to as a "return of excess contribution". These contributions that are returned to the individual are not eligible for the saver's credit. 

Distributions from Retirement Plans May Affect Saver's Credit
Distributions from the individual's retirement plans during what is called the "testing period", may reduce the allowable saver's credit amount or result in the individual being ineligible for the credit. The testing period is the two years preceding the year for which the credit is claimed, or January 1 to April 15 of the year following the year for which the credit is claimed. For instance, if the saver's credit is claimed for 2009, distributions that occur during tax years 2008 and 2007, and from January 1, 2008, to April 15, 2009, could affect the individual's eligibility to claim the credit.

Conclusion
The saver's credit was made available for tax years 2002 to 2006 under the economic growth and tax relief reconciliation act of 2001(EGTRRA), and was made permanent under the Pension Protection Act of 2006 (PPA). The value of using the saver’s credit to reduce taxes you would otherwise pay cannot be discounted -neither can the opportunity cost of funding one's retirement nest egg. If you think you may be eligible for this saver's credit, be sure to discuss the matter with your tax professional. 

by Denise Appleby (Contact Author | Biography)

Denise Appleby is a retirement plans consultant, freelance writer and editor. Before starting her own business, Appleby Retirement Consulting, Denise worked for Pershing LLC for almost 10 years. While at Pershing, Denise rose to the rank of vice president, and held many positions including retirement plans product manager, manager of the retirement plans technical assistance group and retirement plans training manager. Appleby Retirement Consulting provides technical assistance to financial institutions and financial professionals; content for newsletters, websites and magazines; and technical editing services for books and other retirement plans material. Denise holds several retirement professional designations.