Tax season essentials: One tip that can make all the difference

The president of the Transamerica Center for Retirement Studies details findings about the saver’s credit and other highlights from a 300-page study

Half of American workers could qualify for a key IRS tax credit, but many opt out because they don't self-identify as being low or moderate income. (Photo: Thinkstock) Half of American workers could qualify for a key IRS tax credit, but many opt out because they don't self-identify as being low or moderate income. (Photo: Thinkstock)

With tax season well underway, your clients are no doubt busily working through 1040 forms and tracking down expenses that can reduce tax liabilities come April 15.

Often overlooked amid the flurry of activity is the IRS’ retirement savings contribution credit.

Available to people contributing to a qualified retirement plan or IRA, the “saver’s credit” can reduce modified adjusted gross income for tax filers by thousands of dollars. And, contrary to a common conception, those on low incomes aren’t the only folks eligible to use the credit.

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For married couples filing jointly and with a combined income of up to $61,500 in 2016 and $62,000 in 2017, a credit rate ranging from 10 percent to 50 percent can be applied to retirement plan and IRA contributions up to $4,000. The maximum credit is $2,000 if each spouse contributes $2,000 to his or her retirement account.

That’s not chump change. Nor is it a benefit only of value for tax purposes. Catherine Collinson, president of the nonprofit Transamerica Institute and Transamerica Center for Retirement Studies, says the credit could incentivize workers to save for retirement or, if already contributing, to sock away more in their nest eggs.

For insurance and financial service professionals, she adds, the availability of the credit (in addition to the tax-favored treatment of qualified retirement plans) is also a great conversation-starter during a client engagement. Not least, broaching the topic can help position them as trusted advisors.

During a 40-minute-plus phone interview, Collinson detailed findings about the saver’s credit, as well as other highlights of a 300-page study released in December, the “17th Annual Transamerica Retirement Survey: A Compendium of Findings about American Workers.” The following are excerpts.

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LHP: How long has the retirement saver's contribution credit been in existence?

Collinson (pictured at right): The saver's tax credit was enacted as part of EGTRRA [Economic Growth and Tax Relief Reconciliation Act] in 2001 and made permanent by the Pension Protection Act of 2006. We at the Transamerica Center for Retirement Studies are on a mission to increase awareness of this tax credit.

Surprisingly, now that the credit is 15 years old, only about 1 in 3 workers know about it. The good news is that awareness has increased over the years.

LHP: Why is there not greater awareness? Is there not enough employee education happening in the workplace?

Collinson: We have several working theories. The first relates to the IRS description: Their documents call it a tax credit available to low to moderate income savers. But over the years, eligibility for the credit as a function of income has increased.

We're concerned that many people may be eligible, but are not self-identifying as being low or moderate income. In fact, half of American workers could meet current income eligibility requirements. For married couples filing jointly, the limit is a modified adjusted gross income of $62,000 in 2017, up from $61,500 in 2016.

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Many who are eligible to benefit from the saver's credit are using Form 1040EZ— when they should be filing with Forms 1040, 1040A or 1040NR — and so don't get the tax benefit. (Photo: iStock)

LHP: What are the other reasons for the lack of awareness?

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Collinson: Another working theory is that it sounds too good to be true: that someone can save for retirement on a tax-favored basis — pre-tax contributions to a 401(k) grow tax-deferred — and get a tax credit to boot. Because of these dual advantages, I'm concerned that people may be confusing the two benefits or, as I say, see the credit as too good to be true.

Lastly, the saver's credit is not available on the IRS' Form 1040EZ. Many who are eligible to benefit from the credit may be using this form — when they should be filing with IRS Forms 1040, 1040A or 1040NR — and so don't get the tax benefit.

LHP: Whether people are aware of the tax credit or not, I would think the tax guidance available through popular tax preparation software recognizes the saver’s credit?

Collinson: In theory, tax preparation software should catch the oversight. But if the software starts by asking the question, "Which tax form do you want to use?" they may incorrectly elect Form 1040EZ.

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LHP: To what extent is the saver's credit encouraging people to take tax greater advantage of their employer-sponsored 401(k) or other tax-qualified retirement plan?

Collinson: We do think the saver’s credit has a positive impact, though our research doesn’t offer insight as to degree it has encouraged non-savers to start saving. One thing we do know: People are far more likely to be saving for retirement if offered employer-sponsored benefits, including a 401(k) or similar plan.

There are so many factors that drive savings rates — the presence of a matching contribution, payroll deductions, corporate messaging about joining the plan, auto enrollment and auto escalation — that it would be difficult to isolate the saver's credit as a factor underpinning contributions to a 401(k).

With regard to advisors, some of their clients may be eligible to benefit from the credit, so it's a great conversation-starter — including with older clients. As we see from our research, usage of advisors typically increases with age; boomers are more likely than millennials to turn to a financial professional.

LHP: The Transamerica survey finds that, depending of their level education, between 31 and 37 percent of Americans say that making the saver's credit available to all tax filers, regardless of whether they have to pay taxes, should be a priority of the new president and Congress to better prepare for a financially secure retirement. Is this percentage range about what Transamerica expected?

Collinson: Yes. Our researchers posed this same question elsewhere in the survey to see also how answers varied by household income, employer size, ethnicity and gender. Across all demographic segments, fully funding Social Security is the most cited priority.

With respect to making the saver's credit available to all tax filers, response rates for those flagging it as a high priority are similarly high. The response rate is highest among those with some trade school or college education, as well as college graduates.

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The Transamerica study reveals a high percentage of workers who say they haven't fully recovered from the Great Recession. Financial confidence has also stagnated since 2014. (Photo: Thinkstock)

LHP: Considering all of the survey’s findings, were there any surprises?

Collinson: We've been closely following how people's retirement confidence has correlated with the economic recovery since the Great Recession of 2007-2009. What intrigued and surprised us this year is the high percentage of workers who say they've either not fully recovered or were not impacted by the recession.

When we reviewed responses from earlier years, we saw a dip in confidence that coincided with the timing of the recession, then a gradual improvement in confidence post-recession. But confidence levels have stagnated since 2014.

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LHP: Why might that be?

Collinson: One factor is economic trends, including real wages that, when factoring in inflation, are stagnating. Another big factor is the lack of retirement preparedness among an aging population.

In 2015, the first Gen Xers turned age 50. And in 2016, the oldest boomers turned 70. At these critical cross-roads, retirement looms larger on the horizon. And there's a growing realization among these groups that they haven't put away enough to meaningfully self-fund retirement.

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Still other factors could be depressed financial confidence levels fed by worries about the future of Social Security and fast-rising healthcare costs.

LHP: There's a new book out, "The Gig Economy," which offers advice and tips for the growing number of workers who are self-employed — people who don't have access to a 401(k) plan. Are retirement needs and trends among these folks an area of focus for Transamerica?

Collinson: We closely track contributions to individual retirement accounts, many of which are self-employed folks who open an IRA when rolling assets over from a 401(k) or 403(b) plan. But it's hard try to capture in full how these people are saving.

To your point, given the growth of self-employment in the gig economy — and employers' growing preference for freelancers versus full-time employees — we expect IRAs to be a big area of growth.

LHPThe Transamerica report also finds that between 21 and 37 percent of employees want voluntary protection products apart from health insurance — including critical illness, long-term care, disability income and life insurance — as part of a benefits package. Are employers falling short in offering these products?

Collinson: Yes. There's a high response rate among workers who say they value the various voluntary protections products as important benefits. But we also see that employers offer these benefits to a smaller percentage of workers than those desiring the products. That tells us there's a substantial unmet need — and an opportunity for agents and advisors — around workplace benefits.

There's also a big opportunity for advisors serving both employer clients and individual clients who are planning to work longer and retire at older ages because they need income to bridge a retirement savings gap. But deteriorating health or a catastrophic event can short such plans, a possibility that increases as we age. So voluntary protection products can play a really important role as part of a back-up plan.

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Nearly half of Transamerica Center for Retirement Studies' survey respondents say they want 401(k) plans to offer the option to pay retirement benefits in a form that guarantees a set monthly income for life. (Photo: Thinkstock)

LHP: Returning to the gap you identified — between employees' interest in supplementary voluntary benefits and what their companies offer — does this not represent a risk for employers? To the extent these benefits are not being provided, I imagine that valued and talented workers may be inclined to leave for a company offering a more generous package. Thoughts?

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Collinson: I can't speak to protection products, but in one survey question we did ask participants how likely they would be to leave their current employer to take a nearly identical job with a similar employer offering a better retirement plan.

Most workers — 60 percent — whose employers do not offer a retirement plan said they would be likely to switch jobs for a similar job with a retirement plan, a survey finding that has remained unchanged since 2015. Among all workers, 54 percent said they would switch jobs for a better retirement plan, representing an increase since last year.

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LHP: How are innovations in automated asset allocation tools impacting employees’ retirement plan investment selections?

Collinson: In other Transamerica surveys, we have asked about take-up rates for target-date funds, target-risk funds, strategic allocation funds and professionally managed accounts. And we do see a high level of interest among workers —including millennials — in take-up rates for these portfolio solutions, which grow more conservative as you age.

These options let plan participants invest in professionally managed services or funds tailored to their goals, years to retirement, and/or risk tolerance profile. More than 8 in 10 plan sponsors now offer some form of managed account service and/or asset allocation suite.

LHP: Turning to annuities, do you foresee more employers offering these products as qualified default investment options or QDIAs in 401(k)s and other defined contribution plans?

Collinson: In another question about retirement security priorities for new the president and Congress, 46 percent of respondents said they want 401(k) plans to offer the option to pay retirement benefits in a form that guarantees retirees a set monthly income for life. This response rate was second only to the percentage of workers who want reforms implemented to ensure that Social Security is fully funded.

Annuities are clearly on peoples' radar screens. A growing number of workers are looking to effectively pensionize a part of their nest egg. As more employers phase out defined benefit plans, interest in guaranteed retirement income products as part of defined contribution plan are sure to increase.

See the Transamerica Center for Retirement Studies infographic on the next page for highlights about the benefits and mechanics of the saver's credit. (Double-click on image to enlarge.)

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