The “saver’s credit’ is an income tax credit specially designed to encourage lower-income workers to save for retirement, also offering an incentive to participate in the employer-sponsored retirement plan. According to the IRS, the five-year-old credit, originally introduced as part of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), helps offset part of the first $2,000 workers contribute to IRAs and to DC plans and was made permanent by the Pension Protection Act (PPA). Income limits are now adjusted annually to keep pace with inflation.

Though the maximum saver’s credit is $1,000 ($2,000 for married couples) the IRS cautioned in its latest reminder that it is often much less and, due in part to the impact of other deductions and credits, may not apply at all to some taxpayers. It is a credit, not a deduction, so it reduces the federal income tax participants pay on a dollar-for-dollar basis. However, that amount is reduced by the amount of any taxable distribution received by the taxpayer during the testing period. Tax agency officials said a taxpayer’s credit amount is based on his or her filing status, adjusted gross income, tax liability, and amount contributed to qualifying retirement programs.

Eligibility

Generally, people are eligible if they:

• are 18 or older
• are not a full-time student
• are not claimed as a dependent on someone else’s tax return
• are a married couple filing jointly with incomes up to $52,000 in 2007 or $53,000 in 2008
• are a head of household with incomes up to $39,000 in 2007 or $39,750 in 2008; or
• are married individuals filing separately or singles with incomes up to $26,000 in 2007 or $26,500 in 2008.

In 2005, the most recent year for which complete figures are available, the IRS said saver’s credits totaling more than $900 million were claimed on nearly 5.3 million individual income tax returns. Saver’s credits claimed on these returns averaged $216 for joint filers, $149 for heads of household, and $140 for single filers.

“We want low- and moderate-income workers to know about this valuable credit so they can effectively plan ahead and take full advantage of it,” said Richard J. Morgante, commissioner of the Wage and Investment Division of the IRS, in the announcement. “Now that a growing number of employers are automatically enrolling their employees in 401(k) plans, the saver’s credit offers many workers who save for retirement an added bonus.”

The agency said taxpayers have until April 15, 2008, to set up a new IRA or add money to an existing IRA and still get credit for 2007. However, deferrals to a DC plan must be made by the end of the year.

Certain retirement plan distributions reduce the contribution amount used to figure the credit. For 2007, this rule applies to distributions received after 2004 and before the due date (including extensions) of the 2007 return.

Application to Employer

The Saver’s Credit offers advisers another way to encourage people who don’t normally enroll in their employer’s retirement plan to participate.

From a plan standpoint, the application of the Saver’s Credit has no administrative impact. Contributions eligible for the credit are included in regular discrimination tests, and even contributions made through an automatic enrollment program are eligible for the credit.

Part of the reason for the broad application may by due to the kinds of contributions that are eligible, that encompasses salary reduction contributions to a 401(k) plan – including a SIMPLE 401(k); a section 403(b) annuity; a governmental 457 plan; a SIMPLE IRA plan; or a salary reduction SEP are all eligible for the credit, as are voluntary after-tax employee contributions to a tax-qualified retirement plan or section 403(b) annuity. Additionally, the credit is available for contributions to a traditional or Roth IRA.

Form 8880 is used to claim the saver’s credit and its instructions have details on calculating the credit correctly. The IRS reminder is located here. More information is available here.