By FPA member Eric S. Toya, CFP®

Last Updated: March 7, 2011

If you earn a low- to moderate-income and are working to make ends meet, saving for retirement may seem like an impossible goal. An often overlooked tax credit, called the Savers Credit, may make retirement saving a bit less daunting. For more information, read this Internal Revenue Service press release.

You may be eligible for the Savers Credit if you made a contribution to an employer sponsored retirement plan, such as a 401(k) or a 403(b), or an Individual Retirement Account (IRA), and meet the income limitations. Unfortunately, very few workers who may be eligible are aware of this tax benefit. According to a recent study by the Transamerica Center for Retirement Studies, “only 12 percent of American workers with annual household incomes of less than $50,000 are aware of the credit.” ¹

In order to be eligible for the credit, you must be 18 or older, not a full time student and cannot be claimed as a dependent by another person. Based on your filing status, here are the income limitations:

• Single, married filing separately, or qualifying widow(er), with income up to $27,750
• Head of Household with income up to $41,625
• Married Filing Jointly, with incomes up to $55,500

If you made eligible contributions to a qualified retirement plan and meet the income limitations, you may be able to take a tax credit of up to $1,000, or $2,000 if filing jointly. The credit is a percentage of your retirement plan contribution up to a contribution of $2,000 for individuals, or $4,000 combined for married couples filing jointly. The maximum credit amount is 50 percent of your retirement plan contribution.

The Savers Credit does not affect your other tax benefits, including the ability to exclude retirement savings from your income or earn tax deferred or tax free growth on your retirement savings. This means that your retirement contribution may pull double (or triple) duty in providing tax benefits today. You get the tax deductibility, the tax credit and tax deferred or free growth.

Consider how it works for a married couple, making a combined $33,500. If they made a contribution of $4,000 to an IRA or 401(k), they would receive a deduction of the full $4,000 from their taxable income. Since they are in the 15 percent tax bracket, the tax savings from that deduction would be $600. Additionally, if the couple met the qualifications for the Savers Credit, the retirement contribution would earn them a credit of $2,000. Their tax savings would total $2,600. Effectively, it would “cost” them $1,400 to save $4,000. If this savings is going to an employer 401(k) plan that includes employer matching contributions, the benefit is multiplied. However, employer matching contributions do not count for the credit.

This may be an effective way for a parent or grandparent of an adult child to gift money. If you have an adult child who is no longer in school, and qualifies for the income limitation, you may be able to make a gift that will not only help them get started in saving for tomorrow’s retirement, but the tax benefit will help their cash flow today. Be sure you consider gift tax limits if you plan to make a gift of this nature.

It’s not too late to make a contribution to an IRA or Roth IRA for 2010. You have until April 18, or the tax filing deadline, to make contributions for the 2010 tax year.

¹ Transamerica Center for Retirement Studies; Few Workers Aware of Federal Income Tax Retirement “Saver’s Credit”

FPA member Eric S. Toya, CFP®, is Vice President of Wealth Management for Trovena, LLC in Redondo Beach, Calif. Eric graduated from the University of Southern California with a BS in Finance and Accounting and is a current member of the FPA Los Angeles Chapter Board of Directors. Eric has been quoted in national publications, including The Wall Street Journal, Money Magazine and the Los Angeles Times.