The Savers Credit and Savers Match

 

I am looking at a tax change for 2027.

It is an expansion of an existing retirement provision, one that I very rarely see because of its income limitations. I like the intent, however.

Let’s talk about the retirement savers match, which is the post-2026 version of the retirement savers credit. The credit was created in 2001 in an effort to encourage low- and moderate-income workers to save for retirement. It provided a tax credit of 50% on retirement contributions of up to $2,000. The maximum credit per person was therefore $1,000 ($2,000 times 50%). The maximum for qualifying marrieds would be twice that amount: $2,000 for the two spouses.

There were two immediate issues with the savers credit. First, the income limitations were relatively low and - in addition – clumsy. For example, here are the income limitations for marrieds filing jointly: 

		50%	20%	10%
		Adjusted Gross Income Of
Married filing jointly		$48,500	$48,501 to	$52,501 to
		and below	$52,500	$80,500

Marrieds with AGI of $70 grand and contributing $1,500 to a 401(k) would receive a credit of $150 ($1,500 times 10%) – maybe.

The second issue was that “maybe”: the credit was nonrefundable. Say that your tax had already been reduced to zero (via child tax credits, for example). Your savers credit of $150 would now be worth $-0- because tax was already at zero and any excess below zero could not be refunded.

There is no surprise that the Aspen Institute estimated that only 25% to 30% of eligible taxpayers even claimed the savers credit.

Starting in 2027 the savers “credit” will change to a savers “match.”

While the income limitations remain relatively low, there are two main changes:

(1)  The credit is now refundable, and

(2)  The money will go to your retirement account, not to you via a tax credit. There is a de minimis exception of $100, in which case you can choose to treat the match as a tax credit on your return.

Congress replaced the 50%/20%/10% scheme with something closer to a sliding scale, with a slight bump in allowable income.

		Full 50%	Partial	No
		Match	Match	Match
		Adjusted Gross Income Of
Married filing jointly		$41,000	$41,001 to	$71,000
		and below	$70,999	and above

There are - of course - eligibility requirements:

• Be at least age 18 by the end of the tax year.
• Make qualifying retirement savings contributions.
• Not be claimed as someone else’s dependent.
• Not be a qualifying full-time student.
• Meet the applicable income requirements.

You can anticipate a bit of behind-the-scenes programming to make this work. For example, say that your employer offers a 401(k) and elects to accept the savers match to your account. Implementation is going to require time. Fortunately, the first returns to qualify for the match will the 2027 returns due on April 15, 2028. The old law is still in place for 2026 returns due on April 15, 2027.

COMMENT: Note that the money is from the federal government, not from your employer.

While an employer may accept the match, it is not required to do so. I presume that the match would instead go to an IRA in your name, as it cannot go to your employer-based plan.

BTW one does not need an employer-based plan to power the match. The match is looking at retirement savings, and a contribution to your IRA will work. In fact, one could fund a Roth IRA and still receive the savers match. Mind you, the match would be pre-tax (that is, like a regular IRA) and not Roth, but it is still free money.

Not surprisingly, rollover contributions will not qualify. The Code is looking for fresh retirement money.

There is also a clawback should someone abuse the intent of the match. Withdrawal of contributions generating a match during a “testing period” will allow the IRS to recover 100% of the match. Congress wants to reward long-term savings, not short-term binges.

Thinking About The New Medicare Taxes

You may recall that Obamacare incorporated certain tax increases, albeit delayed in some cases. I have been revisiting the payroll tax changes that will kick-in in 2013. 

The High-Earnings Medicare Tax

Beginning in 2013 the employee Medicare tax will increase if the employee is high-earning, defined as $200,000 for singles and $250,000 for marrieds. One’s tax rate will go from 1.45% to 2.35%.  Remember that there is no income limit on the Medicare tax.

Note that the employee and employer will be paying different tax rates.

There are peculiar things about this tax increase. For one thing, one’s Medicare tax rate will be affected by a spouse’s income.

EXAMPLE: Al makes $175,000 and his wife makes $100,000. In 2013 their combined income is $275,000 and subjects them to the increased 0.9% Medicare tax. The tax increase is levied on the excess earnings over $250,000, which is $25,000 ((175,000 + 100,000)-250,000).

Here is the problem: how will Al’s employer (or his wife’s) know this? They won’t. The IRS has said that an employer is required to withhold only on the employee’s wages and disregard the earnings of the spouse. Therefore, as long as a married employee is below $250,000, the employer does not have to withhold the higher tax.

Here is my problem: I am going to be as popular as bedbugs when I come in at year-end and point-out the tax due to Al and his wife.

Also, since when is one’s Medicare tax affected by a spouse’s income? This is a first, to the best of my knowledge.

The Investment Income Tax

Let’s start off with the easy part: the same $200,000 and $250,000 income limits apply.

If one’s income exceeds the limit ($200,000 or $250,000), then one will have a tax hike of 3.8% on one’s net investment income. Net investment income includes interest and dividends (the classics), but it also includes net capital gains, rents (unless it is from a trade or business), royalties and some annuities. It does not include distributions from qualified retirement plans, including distributions in the form of annuities from such plans.

Let’s go with an example.

EXAMPLE: Let’s say that Jeff and Candy have combined salaries of $235,000 and combined interest and dividends of $ 32,000. Their AGI is $267,000. They have exceeded $250,000, so they are in trouble. How much is subject to the new tax? It would be the lesser of the net investment income ($32,000) or the excess over $250,000 ($17,000). Their brand-new tax for 2013 will be $646 ($17,000 times 3.8%).

Some things about this make me uncomfortable. Say that Jeff and Candy earned $213,000 instead, with the same $32,000 in interest and dividends. Their AGI is $245,000 – below $250,000 and thus avoiding the new investment income tax. However, say that they break a 401(k) to pay family medical bills or higher education expenses. Say they break $40,000. This would put their AGI at $285,000. What just happened?

Here is what happened: we have just subjected Jeff and Candy to the new tax. They will owe tax on the lesser of (1) their net investment income ($32,000) or (2) the excess of their AGI over $250,000 ($35,000). The 401(k) break just cost them $1,216 ($32,000 times 3.8%). If Jeff and Candy are under 59 ½, remember that it also cost them the 10% penalty. And income taxes on the break itself.

Again, since when have we paid Medicare tax on unearned income?

Anyway, if you are in these income ranges, you may want to start thinking about the year after next. I can immediately see the appeal of Roths and municipal bonds under this tax regime, as they will not increase one’s AGI. On a darker side, I wonder if we will see higher-income singles less willing to marry – or alternatively higher-income marrieds more willing to divorce – for tax reasons.  Taxes encourage changes in behavior. We just don’t know yet what changes these will encourage.