Saver's Credit Can Spur Retirement Plan Contributions

[This article has been updated for tax filing in 2021 from an earlier version posted last year.]

Many workers don't know that they're eligible for a tax credit by saving in an employer-sponsored retirement plan or individual retirement account (IRA)—and that could be costing them money. Tax time, however, is prime time for employers to inform eligible workers about the saver's credit.

The Retirement Savings Contributions Credit, or saver's credit, is available to low- and moderate-income workers who are putting money aside for retirement. But only 42 percent of U.S workers know about the saver's credit, according to the nonprofit Transamerica Center for Retirement Studies in Los Angeles, which surveyed 5,277 employees last fall.

"Tax season is an ideal time to tell eligible workers how they can earn extra tax credits by saving through their employer's 401(k) or a similar retirement plan," said Catherine Collinson, president of the Transamerica Center. "The saver's credit might just be the motivator for those not yet saving for retirement to get started."

Scott Spann, a senior financial planner with Financial Finesse, a provider of workplace financial wellness programs in Charleston, S.C., said, "Saving for retirement is a challenge for many households in America. Special tax incentives help make the process of saving easier."

What Is the Saver's Credit?

Like other tax credits, the saver's credit can increase a taxpayer's refund or reduce the tax owed. Here's how it works:

The amount of the credit is a maximum of 50 percent of an employee's retirement plan contributions up to $2,000 (or $4,000 for married couples filing jointly), depending on the filer's adjusted gross income as reported on Form 1040. Consequently, the maximum saver's credit is $1,000 (or $2,000 for married couples filing jointly).

The saver's credit "is different than a tax deduction due to the fact that a tax credit is a dollar-for-dollar reduction of your gross tax liability, which is the total amount of taxes you're responsible for paying before any credits are applied," Spann explained.

The saver's credit also differs from the separate tax benefit of contributing pretax dollars to a qualified retirement plan, such as an employer-sponsored 401(k) or an IRA. "Many eligible retirement savers may be confusing these two incentives because the notion of a double tax benefit"—pretax contributions and an additional tax credit—"seems too good to be true," Collinson said.

Who Can Claim the Saver's Credit?

The credit is available to workers age 18 or older who have contributed to a company-sponsored retirement plan or an IRA in the past year and meet the income requirements shown in the table below. The filer cannot be a full-time student nor claimed as a dependent on another person's tax return.

[SHRM members-only toolkit: Designing and Administering Defined Contribution Retirement Plans]

Income Caps for Tax Years 2020 and 2021

For eligible workers, the amount of the available tax credit diminishes as adjusted gross income (AGI) rises. To help preserve the credit's value, income thresholds are adjusted annually to keep pace with inflation. Below are the AGI caps for tax year 2020 (for tax returns filed this year) and 2021 (for returns filed next year).

*Includes qualifying widows and widowers.
Source: IRS.

Deadlines for Retirement Contributions

"You must make eligible contributions to your employer-sponsored retirement plan or IRA for the tax year for which you are claiming the income tax credit," Spann said.

While 401(k) contributions for a tax year can be made only up to Dec. 31, those who are eligible but did not save last year can still make a tax year 2020 IRA contribution until April 15, 2021.

Filing for the Saver's Credit

Employers can advise eligible workers to take the following steps to claim the saver's credit, according to the Transamerica Center:

• If using tax-preparation software, including those programs offered through the IRS Free File program, use Form 1040 or Form 1040NR for nonresident aliens. Answer questions about the saver's credit, which may be referred to as the Retirement Savings Contributions Credit or the Credit for Qualified Retirement Savings Contributions.
  

• If preparing tax returns manually, complete Form 8880, Credit for Qualified Retirement Savings Contributions, to determine your exact credit rate and amount. Then transfer the amount to the designated line on Form 1040 (Schedule 3) or Form 1040NR.
  

• If using a professional tax preparer, ask about the saver's credit.
  

Financial planners advise having tax refunds directly deposited into an IRA to further boost your retirement savings.

The Transamerica Center has additional information, in English and Spanish, on its Saver's Credit webpage, along with a downloadable fact sheet.
 

Related SHRM Articles:

Remind Workers of These Tax Tips, SHRM Online, March 2021

2021 Wage Cap Rises Modestly for Social Security Payroll Taxes, SHRM Online, October 2020