Let's face it: funding one's retirement plan is not always a priority, and many taxpayers may feel their disposable 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 taxpayers' tax liability to the IRS, and offsets the cost of funding a retirement account.

Saver's Tax Credit Defined
The saver's tax 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 10-50% 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 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:

Credit Rate Married and Files a Joint Return Files as Head of Household Other Filers
50% Up to $35,500 Up to $26,625 Up to $17,750
20% $35,500 – $38,500 $26,625 – $28,875 $17,750– $19,250
10% $38,500 – $59,000 $28,875– $44,250 $19,250 – $29,500
0% $59,000+ $44,250+ $29,500+

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 1
Jane, whose tax-filing status is \'single\', has an AGI of $17,500 for tax year 2013. 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 $29,500, 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 or 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.(Updated for 2013)

Example 2

Susan and John are married and file their federal income-tax return jointly. For 2013, their adjusted gross income would have been $36,000 if they had not made any retirement contributions. During 2013, 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 2013.
As a result of these contributions, their 2013 adjusted gross income is $34,000. By making the contribution, their income tax is reduced and they are eligible for a credit of $2,000. Thus, by saving $4,000 for their retirement, Susan and John have also reduced their taxes .

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". 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 2013, distributions that occur during tax years 2011 and 2012, and from January 1, 2014, to April 15, 2014, could affect the individual's eligibility to claim the credit.

The Bottom Line
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.

Related Articles
  1. Retirement

    Borrowing From Your Retirement Plan

    Left with no alternative but to take money out from your retirement savings? Here are some guidelines.
  2. Retirement

    Tips On How To Use IRAs To Boost Retirement Savings

    According to the Trustees of the Social Security Fund, the fund will be depleted by 2037. Are you ready?
  3. Retirement

    Will Your Retirement Income Be Enough?

    Find out how to determine whether you're on the path to a comfortable retirement, or financial ruin.
  4. Retirement

    Delay In Retirement Savings Costs More In The Long Run

    The effects of compounding make it cheaper over the long term to save for retirement.
  5. Savings

    5 Ways To Lose Your Retirement Nest Egg

    These common mistakes can put your savings at risk. Find out how to avoid them.
  6. Budgeting

    The Demise Of The Defined-Benefit Plan

    Experts are making bleak predictions for your post-work years. Be prepared and plan for your future.
  7. Professionals

    How to Protect Your Portfolio from a Market Crash

    Although market crashes are usually bad news for your portfolio, there are several ways to minimize losses or even profit outright from market movement.
  8. Retirement

    How Robo-Advisors Can Help You and Your Portfolio

    Robo-advisors can add a layer of affordable help and insight to most people's portfolio management efforts, especially as the market continues to mature.
  9. Investing Basics

    Investing $100 a Month in Stocks for 30 Years

    Find out how you could potentially earn hundreds of thousands of dollars by just investing $100 a month in stocks during your working years.
  10. Professionals

    3 Benefits of Working Longer (and Retiring Later)

    There are many reasons why folks in their 60s may want to keep working until at least age 70. Here are three.
  1. What are the risks of rolling my 401(k) into an annuity?

    Though the appeal of having guaranteed income after retirement is undeniable, there are actually a number of risks to consider ... Read Full Answer >>
  2. Why is Panama considered a tax haven?

    The Republic of Panama is considered one of the most well-established pure tax havens in the Caribbean due to extensive legislation ... Read Full Answer >>
  3. How can I determine if a longevity annuity is right for me?

    A longevity annuity may be right for an individual if, based on his current health and a family history of longevity, he ... Read Full Answer >>
  4. Do financial advisors prepare tax returns for clients?

    Financial advisors engage in a wide variety of financial areas, including tax return preparation and tax planning for their ... Read Full Answer >>
  5. How are variable annuities taxed at death?

    If the owner of a variable annuity dies before receiving full payment, his beneficiary must pay taxes on any earnings received. ... Read Full Answer >>
  6. How does a Roth IRA grow over time?

    Your Roth IRA account grows over time thanks to two funding sources: contributions and earnings. While your contributions ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!