Saver's Tax Credit: A Retirement Savings Incentive

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, if you meet the income requirements – 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% and 50% of the individual's eligible contribution of up to a total of $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 have 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:

2017
Credit Rate Married and Files a Joint Return Files as Head of Household Other Filers
50% Up to $37,000 Up to $27,750 Up to $18,500
20% $37,001 – $40,000 $27,751 – $30,000 $18,501– $20,000
10% $40,001 – $62,000 $30,001– $46,500 $20,001 – $31,000
0% More than $62,000 More than $46,500 More than $31,000

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 $18,500 for tax year 2017. 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 $31,000, 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 2017)

Example 2

Jill, who works at a retail store, is married and earned $37,000 in 2016. Jill’s husband was unemployed in 2016 and didn’t have any earnings. Jill contributed $1,000 to her IRA in 2016. After deducting her IRA contribution, the adjusted gross income shown on her joint return is $36,000. Jill may claim a 50% credit, $500, for her $1,000 IRA contribution.

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 2017, distributions that occur during tax years 2015 and 2016, and from January 1, 2016, to April 15, 2016, 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 not funding one's retirement nest egg if you don't take advantage of this credit. If you think you may be eligible for this saver's credit, be sure to discuss the matter with your tax professional.