Don't miss Uncle Sam's credit on retirement saving
If your household income last year was $57,500 or less, you could be leaving money on the table this tax season.
Uncle Sam offers a tax credit that can be worth up to half of what you contribute to a traditional individual retirement account (IRA), Roth or workplace retirement plan. The Retirement Savings Contribution Credit - a.k.a the Saver's Credit - is only available to taxpayers with moderate or low income.
Many people who qualify for the credit aren't benefiting: only 20 percent of taxpayers with income under $50,000 are aware that the credit exists, according to a survey by the Transamerica Center for Retirement Studies (TCRS).
A 50 percent break on retirement savings sounds like a pretty good deal, and it can make a dent in one of the nation's biggest retirement problems: low saving rates among low- and moderate-income households. The question is, how to get more people to use it.
HOW IT WORKS
The Saver's Credit provides a credit up to $1,000 ($2,000 for joint filers) for contributions to an IRA or workplace plan.
For the 2012 tax year, it's available to joint filers with adjusted gross income (AGI) up to $57,500 ; single filers get the credit with income up to $28,750 (in 2013, those figures rise to $59,000 and $29,500, respectively).
Even if you didn't contribute to a workplace plan last year, you can make a 2012 IRA contribution before April 15th to claim the credit.
The amount of your credit is based on the amount you contribute, your income and your filing status. For example, a married worker with household income of $30,000 could contribute $1,000 to an IRA, and claim a 50 percent credit, or $500, for her contribution (to determine your credit, see IRS Form 8880.
WHY IT'S IMPORTANT
The Saver's Credit takes aim at the lack of pension coverage among lower-income workers. Just 11 percent of workers in the lowest quintile of earnings were covered by any kind of workplace pension in 2010, according to the Center for Retirement Research at Boston College.
Even workers who do have access to a 401(k) often aren't able to save enough for retirement.
Vanguard reports that the average contribution rate among participants in plans it administers averaged 7.1 percent in 2011, down slightly from the peak of 7.3 percent in 2007. Vanguard attributes the flat contribution levels to the number of workplace plans that have adopted automatic enrollment features for new workers. That boosts participation rates, but most of these plans default to a 3 percent contribution rate - far less than the 10 percent most workers need to be socking away.
"As a country, we aren't saving enough," says David John, senior research fellow at the Heritage Foundation. "With the saver's credit, we can start to boost lower income workers into a better savings range, where it would actually have an impact."
MAKING IT WORK
Unfortunately, the Saver's Credit is a well-kept secret. One culprit is the 1040 EZ tax filing form - which is used by many lower-income households that don't itemize deductions says Catherine Collinson, president of TCRS.
"You can't take the credit on the 1040 EZ form," says Collinson. Instead, "you have to read through all the fine-print instructions to learn that you could be taking this credit if you contributed to a retirement account. It would be great if the 1040 EZ and tax preparation software programs did a better job alerting people that they may want to use a different form."
The credit could be used by many more households if some changes were made to the way it works. The credit is useful only for households that actually owe taxes. Because it is not refundable, it is useless for households that have no federal income tax liability to offset its value.
"The fact is, this is a policy that is based on reducing tax liability, and it ends up being no incentive at all to save for retirement for the people most designed to help," says John, who is also deputy director of the RSP.
The RSP has recommended making the credit refundable - that is, available no matter what your tax liability. John also would like to see it deposited directly into a saver's account to accelerate account growth.
"One problem with the saver's credit is that it essentially encourages people to spend the money, since it comes back as a refund check," says John. "We've proposed sending the refund back to the retirement account, essentially turning it into a matching contribution.
The Obama Administration has backed both ideas in past budget plans, but the idea hasn't gained traction due to the expense of making the incentive available to many more households. The RSP estimates that making the Saver's Credit refundable would cost $112 billion over 10 years.
So, don't hold your breath for reforms anytime soon. But if your income is in the right range, pay close attention to those tax forms this spring, and claim your credit. To make a real difference, take that credit and apply it to next year's retirement account contribution.
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