Generally, taxpayers with lower incomes do not have sufficient financial resources to make retirement savings contributions, often leading to inadequate resources when it comes time to retire in the future. Recognizing this problem, Congress added the Retirement Savings Contributions Credit (Savers Credit) to the tax code a few years back.
What this means is that lower-income taxpayers can have a portion of their retirement savings contributions returned to them in the form of a tax credit—a dollar-for-dollar offset of tax—of as much as 50% of the retirement savings contribution. The credit is phased out as a taxpayer’s modified AGI increases over set limits (see table below), and this credit applies only to the first $2,000 of contributions to retirement savings, even though the law allows substantially larger contributions.
If you make or would like to make eligible contributions to an employer-sponsored retirement plan or to an individual retirement arrangement, you may be eligible for a tax credit. Here are some things you need to know about the Retirement Savings Contributions Credit:
Income Limits – For 2010, the Savers Credit applies to individuals with a filing status and income of:
- Single, Married Filing Separately, or Qualifying widow(er), with income up to $27,750
- Head of Household, with income up to $41,625
- Married Filing Jointly, with income up to $55,500
Eligibility Requirements – To be eligible for the credit in 2010, you: (1) must have been born before January 2, 1993, (2) must not have been a full-time student during the calendar year, and (3) cannot be claimed as a dependent on another person’s return.
Credit Amount – If you make eligible contributions to a qualified IRA, 401(k) and certain other retirement plans, you may be able to take a credit of up to $1,000 (or up to $2,000 if filing jointly). The credit is a percentage of the qualifying contribution amount, with the highest rate for taxpayers with the least income. The table below includes the credit percentages for taxpayers with various income levels.
Modified Adjusted Gross Income (1) Applicable
Joint return Head of household Others percentage
Over Not over Over Not over Over Not over
$ 0 $ 33,500 $ 0 $ 25,125 $ 0 $ 16,750 50
33,500 36,000 25,125 27,000 16,750 18,000 20
36,000 55,500 27,000 41,625 18,000 27,750 10
55,500 41,625 27,750 0
(1) This is your regular AGI (last line on page 1 of Form 1040) increased by exclusions claimed for foreign earned income and housing, certain possessions income, and Puerto Rico source income.
Let’s say that you file as a single individual. Your wages for the year are $25,000 (your only income), and you contributed $2,000 to an IRA account. You would receive a credit of $200 figured as follows: using the “other” column for a single individual with a modified AGI of $25,000, the credit percentage would be 10. Ten percent of the $2,000 contribution to the IRA is $200. Assuming that you take the standard deduction, you would be in the 15% tax bracket and the $2,000 contribution would save you $300 in federal income taxes. Thus, your tax is reduced by a total of $500 and the IRA contribution will only cost you $1,500 out-of-pocket after taxes. Depending on your state’s rules, your state tax also may be reduced because of the IRA contribution, furthering lowering your out-of-pocket cost.
Caution – This credit is nonrefundable, which means it can only be used to reduce your tax liability to zero and any unused credit is lost.
Distributions – When figuring this credit, the amount of distributions (not including rollovers) you have received from your retirement plans must be subtracted from the contributions you have made. This rule applies for distributions starting two years before the year the credit is claimed and ending with the extended filing deadline for that tax return. Thus, for tax year 2010, distributions received in 2008, 2009, 2010, and up to October 15, 2011, must be taken into account and reduce the 2010 contributions amount eligible for the credit.
If you would like additional information on how this tax benefit can help you build a retirement account, please give this office a call.