What's a Saver's Credit and how can it help me save more?

If you’re part of the majority of Americans living paycheck-to-paycheck with no emergency savings, then saving for retirement might be the furthest thing from your mind. Fortunately, the IRS offers relief for some folks who might be struggling to save for retirement.   

The Saver’s Credit allows eligible taxpayers to claim a tax credit for contributions made to an employer-sponsored or individual retirement plan (e.g. 401(k) or IRA). A tax credit, unlike a tax deduction, is an offset the IRS gives on taxes you would normally pay, that in this case can be carried over if you don’t pay enough taxes. This credit provides an additional advantage on top of the tax break you already get from your tax-preferred retirement account(s).

You may be eligible for the credit if you are:

  • Age 18 or older
  • Not a full-time student
  • Not claimed as a dependent on someone else’s tax return

The amount of credit you qualify for depends on your annual gross income and the maximum credit you can claim is $2,000 for singles and $4,000 for married couples. The chart in the IRS articles gives you a rough idea for 2020.

If you qualify for the Saver’s Credit, you’ll essentially get a bonus refund on taxes you would otherwise owe, as a reward for contributing toward your retirement.

For example, Ophelia earned $40,000 in 2020 and contributed $5,000 to her 401(k). Her husband, Dan Doubtful, was unemployed – earning zero income for the year. The couple’s Adjusted Gross Income for 2018 was $35,000 after taking into account that Ophelia contributed $5,000 to her 401(k), if Ophelia and Dan elect the standard deduction of $24,000 their taxable income would be $11,000 taxed at a 10% rate. Ophelia  can claim a 50% tax credit for her 401(k) contribution: $2,500.

Their estimated taxes for 2020 would be approximately $1,100 and the $2,500 credit will reduce their taxes to $0. The remaining amount – $1,400 – can be carried forward to next year’s income taxes and can be carried forward up to 20 years until you use it all up. 

Not only did Ophelia defer taxes on her $5,000 contribution (thus lowering her taxable income), she also was able to claim a $2,500 tax credit that reduced her taxes to $0 – with $1,400 left over that she can use to offset her taxes owed in 2021.

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