Editor’s Note: This story originally appeared on SmartAsset.com.
A provision of the $3.5 trillion Democratic budget resolution in Congress may boost the retirement savings of moderate- and low-income workers.
A House Ways and Means Committee proposal in September would make the Saver’s Credit available for tax-free withdrawal to those who do not owe taxes.
If the provision is passed, eligible workers will receive an annual tax credit as a contribution to retirement accounts. This would increase retirement savings by millions of Americans. This is how it works and what it could do for you. What is the Saver’s credit?
First implemented through the Economic Growth and Tax Relief Reconciliation Act of 2001, the Saver’s Credit incentivizes moderate- and low-income workers to save more for retirement.
The credit, which became permanent under the Pension Protection Act of 2006, is worth a portion of a person’s annual contribution to their individual retirement account (IRA) or employer-sponsored retirement plan. This ranges from 50% for lower-income workers down to 10% for those earning a more moderate income. The credit amount is dependent on the person’s income, filing status, and annual retirement contributions. The maximum credit for an individual in 2021 is $1,000, while $2,000 is the maximum that a married couple filing jointly can claim. The credit thresholds change each year. You can find the income limits for the 2021 tax year on the IRS’ website.
Tax credits are different from tax deductions. While traditional IRA and 401(k) contributions are tax-deductible and lower a person’s taxable income, a tax credit reduces the amount of taxes a person owes, dollar for dollar.
Democrats Want to Make Saver’s Credit Refundable
Under current law, the Saver’s Credit is a nonrefundable credit, meaning it can reduce a person’s tax liability down to $0, but it will not result in a cash refund.
Now, the congressional Democrats propose to make the tax credit refundable. This would allow certain filers who have zero tax liability to receive the credit as a contribution to their retirement accounts.
For example, Jill will earn $41,000 in 2021, but her husband is unemployed and will not have any income. If Jill contributes $2,000 to her IRA this year, she will deduct the contribution from her adjusted gross income on her joint tax return, bringing her taxable income down to $39,000.
As a result, Jill and her husband are eligible to claim a 50% credit on her $2,000 IRA contribution, and potentially reduce their tax liability by $1,000.
Under the Democratic proposal, however, if Jill and her husband do not owe any taxes, the $1,000 would be deposited into Jill’s IRA.
Another Measure to Boost Retirement Savings
In addition to the Saver’s Credit provision, the Democrats are looking to require certain employers that do not offer retirement plans to automatically enroll employees in IRAs or 401(k)-type plans.
During the markup of the $3.5 trillion Build Back Better Act, the House Ways and Means Committee in early September voted 22-20 in favor of advancing both retirement-related measures.
Automatic IRAs and Saver’s Credit Enhancements would dramatically increase retirement savings in the United States,” Ways and Means Committee Chairman Rep. Richard Neal, (D-Mass.), stated. In his opening speech, Neal stated that the American Retirement Association has found that these proposals could add up to $7 trillion in additional retirement savings over a seven-year period. It would also create more than “According to recent analysis commissioned by the American Retirement Association, implementing these proposals could add up to $7 trillion in additional retirement savings over a 10-year period — and create more than 62 million new retirement savers.”
Neal added that the two provisions would especially help Hispanic, Asian and Black workers, who are less likely to have access to work-sponsored retirement plans. Neal said the enhancements would result in 7 million new Black savers and 10.8 million new Latino savers.
Now is the time to address these issues head-on. The longer we wait the worse the crisis will get, and millions more Americans are likely to find themselves in dire circumstances in their later years,” Neal stated.
The Democrats are looking to boost the retirement savings of millions of eligible Americans by making the Saver’s Credit fully refundable.
Under the plan, certain filers would be eligible to receive their credit as a retirement account contribution. Democrats are also seeking a change that would require some employers who do not currently sponsor retirement plans to automatically enroll employees in an IRA or 401(k).
A financial advisor can help you plan for retirement, and manage your tax liabilities. Get in touch with a financial adviser today.
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