Retirement Tax Provisions

The federal government subsidizes and incentivizes retirement savings through tax benefits for both individuals and employers. There are a variety of retirement plan options, and their differing requirements can cause confusion and inefficiencies.

For individuals, individual retirement accounts (IRAs) and employer-sponsored savings plans such as 401(k)s work in one of two ways. With traditional IRAs and 401(k)s, people can deduct their contributions to the plan from their taxable income. Withdrawals are taxed as regular income. With Roth IRAs, people pay tax on the contributions, but the withdrawals they make in retirement are not taxed. In all these plans, the contributions grow tax-free, and most people pay less in income taxes than if the tax preference did not exist.

The Saver’s Credit allows taxpayers with low and moderate incomes to claim a credit for contributions they make to various retirement savings plans against income tax owed. These plans include IRAs and employer-sponsored savings plans such as 401(k)s. The maximum credit equals $1,000 for single filers and $2,000 for joint filers. In 2024, the credit was available for taxpayers with an Adjusted Gross Income (AGI) of up to $76,500 for married couples filing jointly and up to $38,250 for single filers. The AGI thresholds are indexed for inflation. Because the Saver’s Credit is nonrefundable, it can be used only to offset tax liability. As a result, it offers little or nothing to many of the people with low and moderate incomes it was designed to help.

Starting with tax year 2027, the Saver’s Match will replace the Saver’s Credit. The Saver’s Match improves upon the Saver’s Credit and addresses its shortcomings. It also provides a match of up to $1,000 for single filers and $2,000 for joint filers for contributions made to a retirement savings account. But unlike the current credit, the match will be paid directly into the taxpayer’s retirement account rather than as a tax refund. It also will be refundable, meaning it would be paid regardless of a saver’s tax liability. Lastly, the Saver’s Match loosens income requirements for eligibility. Joint filers with incomes of $41,000 or less and single filers with income of $20,500 or less are eligible for a full match equal to 50 percent of their contributions. Those with earnings between $41,000 and $71,000 for joint filers and between $20,500 and $35,500 for single filers are eligible for a proportion of the match depending on the contribution and income level. Thus, the Saver’s Match provides an opportunity to improve the long-term financial security for millions of Americans with low to moderate incomes.

Employers can deduct from their taxable income contributions made to workers’ retirement accounts. This is similar to the deduction that they can claim for wages and salaries paid to workers. They can also deduct the costs of operating the plan. While 401(k)s and 403(b)s are the most common retirement plans offered by employers, small business owners have additional options. These include Simplified Employer Pensions (SEPs), SIMPLE IRAs, profit-sharing plans, and employee stock ownership plans.

The various types of retirement savings plans differ in many ways for both workers and employers. For workers, plans vary in terms of:

• income limits,
• limits on contributions,
• withdrawal rules upon retirement, and
• conditions under which participants can access the money in their accounts prior to retirement without a penalty.

Penalties for early withdrawals exist because using retirement funds for nonretirement purposes undermines the purpose of encouraging saving for retirement. Penalties can be waived in certain circumstances.

For employers, plans have different administrative burdens, contribution requirements and limits, and Internal Revenue Service reporting requirements.

In addition, individuals with traditional retirement plans must begin withdrawals from those accounts by the time they reach age 72, gradually increasing to age 75. (Traditional retirement plans are those in which contributions are deducted from taxable income.) Roth 401(k)s are not subject to required distributions until after the death of the owner. This rule ensures that the assets in these accounts do not escape taxation altogether. The Treasury Department uses life expectancy tables to determine the appropriate age threshold for the required minimum distribution (RMD). Those tables have become outdated. Exempting from the RMD assets up to a certain level could help to ensure longer-term retirement savings.