An Individual Retirement Account (IRA) is a tax-advantaged retirement savings plan wherein you contribute either pre-tax or after-tax money that grows on a tax-deferred or tax-free basis. An IRA account helps you save for retirement and also avail of tax benefits. You can take a retirement savings contribution credit based on the amount you invest in an IRA. However, to do so you must qualify for a tax credit to contribute to your IRA. To calculate the tax credit, your total gross income and your IRA contribution amount are taken into account.
This tax credit is also known as the saver's tax credit. The saver's tax credit can be claimed by individuals having a low to moderate income who contribute to IRAs and certain defined-contribution plans such as 401(k), 403(b), SIMPLE, SEP, and more. If you need guidance on how you can claim a saver’s tax credit on your IRA contributions and its benefits, consider consulting with a professional financial advisor who can advise you on the same.
This article discusses the saver’s tax credit, its eligibility criteria, and how you can claim its benefits.
What is the Saver's Tax Credit?
The saver’s tax credit is a tax break for middle and low-income taxpayers. It is a non-refundable tax credit that can be thought of as a subsidy for retirement savings. You can claim a tax credit of up to $1,000 a year as an individual taxpayer, however, if you are married and filing your taxes jointly, you can claim a tax credit of up to $2,000 per year. To avail of the saver’s tax credit, you must make contributions to your IRA.
What is the eligibility criteria for claiming the saver’s tax credit?
To claim the saver’s tax credit, you must be 18 years of age or older and not be a full-time student. You also cannot be claimed as a dependent on another person’s tax return if you wish to file for a saver’s tax credit. As stated above, you must also make an IRA contribution to be eligible for retirement savings credit. The Internal Revenue Service (IRS) sets income slabs according to which an individual can claim saver’s tax credit as per their adjusted gross income (AGI). For 2023, the income limits for claiming saver’s tax credit have been revised as follows:
- Households having a total AGI of $43,500 and below or individuals having an AGI of $21,750 and less can claim saver’s tax credit at a rate of 50%.
- Households having a total AGI of $43,501 to $47,500 or individuals having an AGI of $21,750 to $23,750 can claim saver’s tax credit at a rate of 20%.
- Households having an AGI of $47,501 to $73,000 or individuals having an AGI of $23,751 to $36,750 can claim saver’s tax credit at a rate of 10%.
Do note that any rollover contributions are not taken into consideration at the time of calculating your tax credit. This means that if you switch your job and transfer your retirement funds from one retirement account to another, you will be ineligible to claim a tax credit on those funds. Thus, do not include any rolled over funds while computing your retirement savings credit. In addition, take care to divest any excess contributions made to your IRA account within a stipulated time limit to avail of a tax credit.
Which retirement accounts are eligible for claiming the saver’s tax credit?
There are several company-sponsored retirement accounts and IRAs that are eligible for a tax credit. These are:
1. Company-sponsored retirement accounts
You can claim a saver’s tax credit on the following retirement plans:
401k:
A 401k is a tax-advantaged retirement savings account offered by employers to their employees. The employees contribute their pre-tax income to the retirement account wherein the employer may match the employee contribution either partially or fully.
SIMPLE 401(k):
As the name suggests, SIMPLE 401(k) is a simplified version of a 401(k) offered by small business employers or companies having 100 or fewer employees.
457(b):
A 457(b) is a tax-advantaged retirement savings plan offered to employees working in the local and state governments as well as non-profit organizations.
403(b):
A 403(b) is a retirement savings plan offered to employees of public schools and tax-exempt organizations. Typically, teachers, professors, nurses, librarians, school administrators, government employees and doctors can open a 403(b) retirement account.
SIMPLE IRA:
Similar to the SIMPLE 401(k), small businesses having 100 or fewer employees can use the SIMPLE IRA plan.
Simplified Employee Pension (SEP):
A SEP-IRA is a company-sponsored retirement plan that can be opened by sole proprietors, partnerships, and corporations.
2. Individual Retirement Accounts
You can claim a saver’s tax credit on the following IRAs:
Traditional IRA:
A traditional IRA is a tax-advantaged retirement savings account wherein you contribute your pre-tax dollars and your investments grow on a tax-deferred basis. However, your withdrawals are taxed in retirement.
Roth IRA:
In a Roth IRA, you contribute your after-tax dollars to earn tax-free growth on your contributions. In addition, you can make tax-free withdrawals in retirement provided you meet certain stipulated conditions set by the IRS.
Achieving a Better Life Experience (ABLE) accounts:
An ABLE account is a tax-advantaged account that can be set up for individuals diagnosed with significant disabilities before their 26th birthday. Contributions can be made by beneficiaries, friends, or family members.
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How to compute a saver's tax credit?
To calculate a saver's tax credit, you must apply the appropriate saver's tax credit range between 10% and 50% of the individual taxpayer's AGI. For example, suppose you have an AGI of $21,000 and contribute $1,000 to your IRA. As per your AGI, you are eligible to receive a 50% tax credit on your contribution i.e. $500. That said, if your AGI is $21,000 and you contribute $3,000 toward your IRA, you will receive only $1000 as a tax credit. This is because you can only receive the lesser of either $1,000 or the tax liability you would have had without the credit.
How to claim a saver’s tax credit?
Fill out the IRS Form 8880 and attach it to Form 1040 and submit them at the time of filing your tax returns. Do remember that the tax credit amount will be based on your IRA contributions and AGI.
To summarize
Tax credit can be a source of much-needed relief for low and middle-income taxpayers. It works as an incentive for individuals with low to middle income to set aside some money each month toward their retirement savings goal. The saver’s tax credit helps subsidize that effort. That said, before filing for a tax credit, do check if you meet the eligibility criteria. Also, take care to fill out IRS Form 8880 before submitting your tax returns for the year.
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