Contributors to retirement plans already know the long-term tax advantages of an individual retirement account or 401(k). Taxes are deferred, and in some cases never collected, on money put away for the golden years.
Now a tax credit will let some savers reap the rewards of their retirement thrift early.
The retirement savings contributions credit, also called the saver's credit, appears on Form 1040 and Form 1040A tax returns as a way to reward lower-wage earners who sock away retirement money.
Because the tax break is a credit instead of a deduction, it's a better deal. Tax deductions reduce taxable income, but credits come into play after you calculate how much tax you owe, and they reduce your Internal Revenue Service bill dollar for dollar. For example, if you owe $500 and you are eligible for a $250 credit, the check you have to write to Uncle Sam is cut in half.
A filer eligible for the saver's credit could shave as much as $1,000 off his or her tax bill. The actual credit amount depends on your income, filing status and just how much you put into retirement plans.
Basically, the lower your income, the bigger your credit. The income limits that determine how large a credit you can claim are adjusted annually to keep pace with inflation. The precise credit percentages for 2012 filings are found in the table below.
Retirement savings credit guidelines; earnings are adjusted gross income
|50%||Up to $17,250||Up to $34,500||Up to $25,875|
|20%||$17,251 to $18,750||$34,501 to $37,500||$25,876 to $28,125|
|10%||$18,751 to $28,750||$37,501 to $57,500||$28,126 to $43,125|
|No credit||$28,751 or more||$57,501 or more||$43,126 or more|
As the table shows, the maximum available credit is 50 percent of contributions for filers in the lower end of the earnings ranges. There is, however, a limit on the retirement plan contribution amount you can use to figure the tax break.
Although tax law allowed you to put up to $5,000 in 2012 ($6,000 if you're age 50 or older) in your IRA, only $2,000 of that will count in figuring the saver's credit. That makes it worth at most $1,000 for single taxpayers. Of course, if you're married and you and your spouse put away at least $2,000 toward retirement, your joint return would reflect a $2,000 credit.
Which contributions count?
Contributions to traditional and Roth IRAs as well as to employer-sponsored 401(k) plans count toward computing the credit. So does money you put into a savings incentive match plan for employees, or Simple, plan; a 403(b) program; a governmental 457 plan; or a salary reduction simplified employee pension, or SEP. You can only count the money you put in your workplace account, not any matching amounts your company contributed.