Saving for retirement may have become more affordable for some of your employees
On August 17, 2006 President Bush signed the Pension Protection Act of 2006, making the Saver’s Credit permanent. First introduced as part of the Economic Growth and Tax Relief Reconciliation Act of 2001, the Saver’s Credit is targeted at promoting qualified retirement savings for low to middle income Americans.
The Saver’s Credit helps eligible employees pay less federal income taxes when they save for retirement. By providing an incentive for your employees to save for their retirement, Uncle Sam may also be helping you increase both participation and deferrals in your 401(k) retirement savings plan—as well as increasing your chances of passing ADP testing.
Taking the Credit
Depending on tax filing status and income level, employees who contribute to a qualified retirement account may qualify for a credit of up to $1,000 annually (or $2,000 if filing jointly) on their federal income taxes. Generally speaking, the more an employee saves for retirement, the less they may have to pay in federal income taxes. Important note: The IRS refers to the Saver’s Credit as the “Retirement Savings Contributions Credit” in its publications.
In order to take advantage of the Saver’s Credit, your employees should:
1. Check Eligibility
To qualify, your plan participants must be 18 or older by the end of the tax year. They cannot be a full-time student or be claimed as a dependent on another person’s tax return. There also are annual income limits. The 2006 adjusted gross income (“AGI”) limits are $25,000 for singles, $37,500 for the head of a household, and $50,000 for those who are married and file a joint return. After 2006, the AGI limits increase by $500 annually to allow for inflation.
2. Defer Then Subtract
In general, for every dollar contributed to your qualified retirement plan, up to the lesser of the plan or IRS limit, your participants defer that amount from their current overall federal taxable income. This lowers their current federal taxable income.
The Saver’s Credit then helps them further reduce their federal tax bill. How? They calculate the amount of the credit and subtract it from what they owe in federal taxes. To determine the amount of Saver’s Credit that a plan participant may qualify to take, use the table below to identify the appropriate tax credit rate based on the participant’s tax filing status and AGI.
For example, if a participant makes a $2,000 contribution to a 401(k) for a given year and qualifies for a 50% credit rate, that participant may qualify for a $1,000 non-refundable credit that can be used to reduce their federal income taxes for that year.
3. Claim The Credit
If your participants use a professional tax preparer, remind them to ask their tax professional about the Saver’s Credit, called “Retirement savings contributions credit” on Forms 1040, 1040A and 1040 NR. Or, if they use tax preparation software, direct them to use Form 1040, Form 1040A or Form 1040NR when filing their return. The Saver’s Credit is not available with Form 1040EZ.
Lastly, if they prepare their own tax returns, suggest that they start with Form 8880, “Credit for Qualified Retirement Savings Contributions” to determine their credit rate and corresponding credit amount. Then use Form 1040, Form 1040A or Form 1040NR for filing their return. Transfer the amount of their Saver’s Credit from Form 8880 to line 51 of Form 1040, line 32 of Form 1040A or line 46 of Form 1040NR. If they have questions, direct them to IRS publication 590 or to log onto the IRS Web site at www.irs.gov.