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Retirement Perspectives

Don’t forget about an often overlooked tax credit to certain eligible individuals for contributing to retirement plans. 

Now that tax season is upon us, some advisors and clients may want to see if they qualify for a little-known and underappreciated tax credit for retirement plan contributions. 

While a recent study found that two out of three workers are not aware of that tax credit, the IRS reports that saver’s credits totaling nearly $1.4 billion were claimed on more than 8.1 million individual income tax returns in tax year 2015 (the most recent year for which complete data are available).

Individuals have until April 15, 2018, to make a 2017 IRA contribution and qualify for the credit for that tax year. Even better, the credit can be claimed in addition to receiving a tax deduction for contributing to a traditional IRA.

Background
Saver’s credits were part of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), which was signed into law by President George W. Bush in 2001. In some cases, this credit could reduce the federal income tax you pay dollar for dollar.   (For further information, see IRS Form 8880 “Credit for Qualified Retirement Savings Contributions,” which can help taxpayers in calculating the amount of their tax credit.)

The saver’s credit is a nonrefundable, federal income-tax credit available to certain taxpayers with adjusted gross income (AGI) of less than $63,000 (couples married filing jointly), who make contributions to a traditional or Roth IRA, 401(k), 457(b), SEP, or SIMPLE IRA plan. The maximum annual contribution eligible for the credit is $2,000, and the maximum credit is 50%, making the maximum credit $1,000.

Since the benefit is a credit, rather than a deduction, the credit could reduce investors’ federal income-tax bill on a dollar-for-dollar basis. The saver’s credit can increase your refund or reduce the tax owed. (See 2018 Saver’s Credit table below for a complete list of filer’s AGI limits.)

Who Can Benefit
To qualify, individuals must clear a few hurdles, including satisfying an income test (see Table 1), being at least 18 years old, and not being a full-time student. In addition, individuals who claim the credit may not be claimed as a dependent on anyone else’s tax return. The credit is not available on IRS Form 1040EZ, but is available on Form 1040, Form 1040A, or Form 1040NR.

Determining a Credit
The amount of the credit is 50%, 20%, or 10% of your retirement plan or IRA contributions up to $2,000 ($4,000 if married filing jointly), depending on your adjusted gross income (reported on Form 1040 or 1040A). Use the table below to calculate your credit.

 

Table 1. Who Can Benefit from the Saver’s Credit, and How

Source: Internal Revenue Service.
*Single, married filing separately, or qualifying widow(er).

 

Here are a few questions that I receive frequently:

Q. What deadlines apply in order to receive the saver’s credit?
A.
Two separate contribution deadlines apply. To qualify for the saver’s credit, contributions must be made to 401(k)s, 403(b)s, 457s, or Thrift Savings Plan by the end of the calendar year. However, individuals have until April 17, 2018 (April 15 falls on a Saturday) to make an IRA contribution that could qualify them for the saver’s credit for tax year 2017.

Q. Which retirement vehicles are eligible for the credit?
A.
The saver’s credit can be taken for contributions to a 401(k) plan, traditional or Roth IRA, SIMPLE IRA, SAR SEP, 403(b), or governmental 457(b) plan.

Also, the recently passed tax reform bill added a new account that is now eligible for the saver’s tax credit. The credit, which is normally only available for contributions to retirement accounts, has been expanded to Section 529A ABLE accounts. However, eligibility requires that the beneficiary of the ABLE account is the one who makes the contributions, he/she will then be able to claim the saver’s credit.

Q. Does the saver's credit affect an eligible individual's entitlement to any deduction or exclusion that would otherwise apply to the contribution?
A. No. Eligible individuals entitled to deduct IRA contributions or to exclude pretax contributions from gross income will be able to deduct or exclude those amounts and also claim the saver's credit.

If you have any questions about this or another retirement topic, please e-mail me at roadtoretirement@lordabbett.com.

 

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

GLOSSARY OF TERMS

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

A Simplified Employee Pension plan, commonly known as a SEP IRA, is a retirement plan specifically designed for self-employed people and small-business owners. When establishing a SEP IRA plan for your business, you and any eligible employees establish your own separate SEP IRA; employer contributions are then made into each eligible employee’s SEP IRA.

A SIMPLE IRA plan is an IRA-based plan that gives small-business employers a simplified method to make contributions toward their employees’ retirement and their own retirement. Under a SIMPLE IRA plan, employees may choose to make salary reduction contributions and the employer makes matching or nonelective contributions. All contributions are made directly to an individual retirement account (IRA) set up for each employee (a SIMPLE IRA). SIMPLE IRA plans are maintained on a calendar-year basis.

A simplified employee pension plan (SEP IRA) is a retirement plan specifically designed for self-employed people and small-business owners. When establishing a SEP-IRA plan for your business, you and any eligible employees establish your own separate SEP-IRA; employer contributions are then made into each eligible employee’s SEP IRA.

401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an aftertax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.

A 403(b) plan is a retirement savings plan that allows employees of public schools, nonprofit, and 501(c)(3) tax-exempt organizations to invest on a pretax and or Roth aftertax basis. Contributions to a 403(b) plan are conveniently deducted directly from your paycheck. In addition, your employer may elect to make a contribution on your behalf.

529A ABLE accounts (The Achieving a Better Life Experience (ABLE) Act permits a state to establish and maintain a new type of tax-advantaged savings program (under Section 529A of the Internal Revenue Code) for a qualified disabled person. Similar to 529 college savings plans, they are savings accounts administered by the states. Money can be withdrawn tax-free when the funds are used to pay for qualified disability expenses. The contribution for 2016 is $14,000 (the amount of the annual gift tax exclusion) and many states have total contribution limits that exceed $300,000.

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