Tax Facts

The Saver's Credit

The 2001 tax act created a "saver 's credit" that provides saving incentives for households with moderate income. The saver 's credit provides a matching tax credit for contributions made to IRAs and 401(k) plans. The eligible contributions are limited to $2,000. Joint filers with income of $30,000 or less, and single filers with income of $15,000 or less, are eligible for a maximum 50 percent tax credit. (A 50 percent tax credit is the equivalent of a 100 percent match on an after-tax basis.)

The credit is not refundable. Therefore, despite the apparent generosity of the 50 percent credit rate, it does not result in any additional incentive to save for many tax-filing units in the relevant income range. The table shows that 57 million returns have incomes low enough to qualify for the 50 percent credit. Only one-fifth of these returns, however, could benefit from the credit if they contributed to an IRA or 401(k) because the credit is nonrefundable. Only 64,000 (or slightly more than 1 out of every 1,000) of the returns that qualify based on income could receive the maximum possible credit ($1,000 per person) if they made the maximum eligible contribution.

For filers with higher incomes, the credit phases down quickly to 20 percent and then 10 percent before being eliminated at $50,000 in income for joint filers (and $25,000 for single filers). The result of the steep declines in the credit rate can be massive marginal tax rates for savers. For example, consider a married couple with income of $30,000 in 2003 and no children. Assume the couple claims the standard deduction and one spouse makes a $2,000 contribution. After the saver 's credit, the couple's income tax liability would be about $700. If one spouse earned an extra dollar, however, the couple's income tax liability after the credit would increase to about $1,300—an increase in taxes of about $600 for an increase in income of $1.