The Internal Revenue Service has modified a commonly ignored tax break that allows taxpayers to reduce their tax bill for the upcoming year by as much as $1,500 every year.
The retirement savings contribution credit, often known as the saver’s credit, is a tax credit that offers up to $1,000 in credit to low- and middle-income Americans who make contributions to a qualified retirement plan. Couples who are married can claim up to $2,000 in benefits.
People who are over the age of 18 who are not recognized as dependents by anybody else are able to claim the credit. They must also be self-employed.
Individuals must make contributions to either an Individual Retirement Account (IRA) or an employer-sponsored retirement account in order to be eligible for it.
There are several types of retirement plans that fall under this category, including 401(k), 403(b), and governmental 457(b), as well as any after-tax contributions made to a Thrift Savings Plan.
In addition, there are income limitations that limit who is eligible to receive the tax credit. Single filers will have a new maximum income of $34,000 in 2022, married couples filing jointly will have a new maximum income of $72,000, and heads of household will have a new maximum income of $51,000 in 2022.
Taxpayers who qualify for the credit can receive 10 percent, 20 percent, or 50 percent of the first $2,000 in savings — meaning they might claim either $200, $400, or $1,000 – depending on how much they save.
Higher-earners, on the other hand, will see their credit diminish over time. In order to claim 50 percent of their retirement contribution, individuals must earn less than $20,500 per year, with the maximum amount being $41,000 for married couples and $30,750 for heads of household.
A married couple who earned $41,000 in 2021 and made a $2,000 contribution to their IRA during the year could deduct a 50 percent credit of $1,000 for the $2,000 contribution on their 2021 tax return, resulting in a $1,000 deduction on their 2021 tax return.
It is estimated that only 43 percent of workers are aware of the saver’s credit, according to a recent survey issued by the Transamerica Center for Retirement Studies.
Even more concerning is the fact that only 35% of people with household incomes below $50,000 are aware of the tax credit, despite the fact that they are intended to be the group that benefits the most from it.
Moreover half of the households with incomes greater than $100,000, on the other hand, stated that they were aware of the credit, according to the report.
Tax credits are removed from the taxes that you owe – not from your taxable income – and provide you with a dollar-for-dollar decrease in your tax liability. Tax credits are not available for charitable contributions.
Example: If your federal tax bill is $10,000, and you are eligible to receive an additional $2000 in refunds, your tax liability is decreased to $8,000.
Experts generally believe that tax credits are preferable to deductions when it comes to lowering your tax burden.
As reported by TurboTax, if you were given the option to select between a $100 deduction and a $100 credit, you’d almost certainly opt for the credit because it would cut your tax payment by $100.
The amount of money you save by reducing your taxable income by $100, on the other hand, is determined by your tax bracket. In 2019, if you were in the 24 percent tax bracket, a $100 deduction would decrease your taxes by $24 per $1,000 of income.
Using credit cards, Megan Brinsfield, CPA and director of financial planning at Motley Fool Wealth Management, explained that “credit cards win every time because they are a dollar-for-dollar reduction of your tax burden.”
“In order for deductions to reduce your overall income before applying to your tax rate,” says the author.