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It's fairly common knowledge that contributions to your 401(k), traditional IRA (individual retirement account), and other pre-tax retirement accounts are generally tax-deductible. However, many people aren't aware of the other major retirement savings tax break, the Retirement Savings Contributions Credit, or as it's more commonly known, the "Saver's Credit."
What is the Saver's Credit?
The Saver's Credit is designed to make it easier for low- to moderate-income taxpayers to save and invest for retirement.
To claim the credit, you need to be 18 or older and not a full-time student or a dependent on someone else's tax return. The credit is worth 10%, 20%, or 50% of your retirement plan contributions of up to $2,000 per year for singles or $4,000 for couples, depending on your adjusted gross income (AGI).
To answer one of the most frequently asked questions, contributions to your employer's retirement plan, such as a 401(k), qualify. Here's a list of some of the major types of retirement account types that qualify for the Saver's Credit:
- 401(k) contributions
- Traditional or Roth IRA contributions
- SIMPLE IRA
- 403(b) or governmental 457(B) plans
For the 2016 tax year, here are the AGI thresholds for each tax filing status, and the credit rate you can expect to receive:
Data source: Internal Revenue Service.
How much could you get?
Let's say that you're married and earned $40,000 from your job in 2016, and that your spouse didn't work. We'll say that you contributed a total of $3,000 to IRAs for you and your spouse, making your AGI for the year $37,000. This entitles you to a credit of 50% of your contribution, which translates into $1,500 back in your pocket.
Keep in mind that this is a tax credit, which is better than a tax deduction. A credit means that you simply get that money back -- either added to your refund or subtracted from your tax liability.
In other words, this couple would literally be given $1,500 from the government as a reward for saving and investing for retirement.
The long-term benefits can be fantastic
Even better than the short-term tax benefits are what this could mean to you over the long run. Let's say that the married couple in our example contributes $3,000 to their IRAs every year for 30 years. This is a total contribution of $90,000 over three decades, but since they would have received a $1,500 tax credit each year, they effectively only contribute $45,000.
Using a conservative average return rate of 7% (well below the stock market's historic average), this couple's IRAs could be worth more than $283,000 after 30 years, a $237,000 profit on their investments. That's why this credit is so important to take advantage of.
The bottom line on the Saver's Credit
If you fall within one of the income brackets in the table above and haven't saved as much for retirement as you'd like, this could be the extra incentive you need. The government is offering you an instant 10%, 20%, or 50% return on your investment, as well as an opportunity to set yourself up for financial freedom later in life, so take advantage.
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