Saver’s Credit Reminder

There’s an old expression that says, “A penny saved is a penny earned.” While Uncle Sam may not see things exactly the same, if you meet certain restrictions, a penny saved could be up to ½ a penny earned. The Retirement Savings Contributions Credit, more commonly known as the “Saver’s Credit”, was introduced by EGTRRA in 2001 (effective for 2002) and was later made permanent by the Pension Protection Act of 2006. This provision, which was intended to help bolster retirement savings among those individuals with low income, is possibly of greater importance today than at any time since its inception, thanks to our troubled economy and rising unemployment.

The Saver’s Credit is in addition to any deduction that may have already been received for a retirement plan or IRA contribution and will reduce a person’s tax liability dollar for dollar, but not below zero (meaning that you cannot get a refund of any unused credit). Another important note is that regardless of where contributions are made (i.e. IRA, Roth IRA, 401(k), 403(b), Section 457 plans, or SEP or SIMPLE IRA contributions), the maximum contribution amount eligible for the credit is $2,000. Since the maximum credit rate is 50%, you can potentially reduce tax liability by up to $1,000. On a joint return, the savings could be up to $2,000 if both individuals qualify.

Do You Qualify?

There are a number of qualifications that must be satisfied in order to receive this credit, and even then, as income is increased, the credit is phased out. On the bright side though, unlike many other deductions and credits, this one’s available to any person filing a return, regardless of filing status (although the income phase outs are different). In order to be eligible for the credit, individuals must meet the following criteria.

1. You must be 18 years or older
2. You must NOT be a full-time student
3. You are NOT claimed as a dependent on someone else’s return
4. You have made a new contribution to an IRA, Roth IRA or other defined contribution plan
5. Your adjusted gross income (AGI) is within the limits for your filing status (see the table below)

Caution: Watch the Testing Period

Like most things Congress touches, it has overcomplicated this credit with unnecessary provisions. The one item you must be very aware of is the “testing period.” The testing period consists of the two tax years preceding the credit, the tax year in which the credit is claimed and the year after the credit is claimed up until the due date (including extensions) of the return. During this time, any distributions made from a retirement account will reduce qualifying contributions dollar for dollar, and ultimately, the credit.

For example, a 65 year old man (filing married-jointly) with an AGI of $25,000 in 2011 and contributes $5,000 to a traditional IRA. In addition to the $5,000 deduction, he would also have a credit for $1,000 (50% of the maximum $2,000). If he were to make a withdrawal of $1,100 from an old 401(k) on March 20th 2012, his credit for 2011 would be reduced from $1,000 to $450 (50% of [$2,000 – $1,100]). That same distribution would also limit his credit for 2012, 2013 and 2014.

To make matters worse, if you are a joint filer, any distributions taken by your spouse from a retirement account will also count against you. A final item to be aware of here is that RMDs do count against the credit. So if you are over 70 ½ and have RMDs, you’re probably going to lose out on any possible benefit. Note: You cannot make contributions to a traditional IRA once you reach age 70 ½ (for the year you turn age 70 ½ and for future years), but you can continue to contribute to plans at work, self-employed plans (like SEP and SIMPLE IRAs) and to Roth IRAs after age 70 ½ if you have the income and qualify. For Roth IRA contributions, you must qualify under the annual income limits, which are high enough so that anyone eligible to claim the Savers Credit would have income low enough to qualify for a Roth IRA contribution.

The intent of the testing period provision was to prevent taxpayers from claiming a credit and then immediately withdrawing their contribution. And while you can’t fault Congress for thinking that some people would have taken advantage of that loophole, the inclusion of the testing period muddles what otherwise could have been a pretty straightforward provision.

Planning Possibilities for Financial Advisors

While those who qualify for these tax credits are not high income clients, you never know where this bit of knowledge can come in handy. Perhaps you call some of your 50-60 year old clients and remind them to make sure their grown children are taking advantage of this opportunity. That kind of service and outreach is the value-add that can separate you from the pack. You may also want to remind some of the CPA’s you work with about this credit. It may be only a small sum, but it will remind them of possible missed tax savings for their clients.

Bearing that in mind, here are some things you may want to consider:

1. Double bonus for IRAs – If you have clients that meet all the criteria and they contribute to a traditional IRA, they not only will get a deduction on the contribution, but will also get up to $1,000 credit as well. That’s a pretty good incentive to save.
2. Triple bonus for company plans – If you have clients that meet all the criteria for the credit and participate in company plans with a match, you may want to point out that they are getting a triple benefit from contributing. If they contribute $2,000 or more, they will get the tax deduction for the contribution, the match from the company (“free money”) and the maximum available credit for their income range. That’s an even stronger incentive to save!
3. Roth IRAs –If you have clients over 70 ½ with earned income, they cannot make contributions to traditional IRAs. The Roth IRA, however, has no such age restriction. Plus, if they qualify for the full credit, the tax savings they would receive could act like a “pseudo-deduction.” For example, let’s say you have a 71 year old client that had $30,000 dollars of earned income and files jointly. In this scenario, if he contributed $2,000 to a Roth IRA, he would get a $1,000 tax credit. So basically, Uncle Sam just paid for ½ of his account. Just beware of the testing period here. Remember, if either he or his wife is subject to RMDs, those amounts will reduce, or even eliminate the credit entirely.

The fact of the matter is that this credit may only apply to a small number of your clients, if any at all. But with the economy in disarray, unemployment on the rise and an unpredictable future ahead, you may see more people qualifying for this provision than you think. Just remember – today, more than ever, every dollar counts.

Copyright © 2013 Ed Slott and Company, LLC