Tax Saver's Credit

[MB232]

I am preparing my daughter's taxes and I have a question about the Saver's Tax Credit.  She changed jobs both in 2023 and 2024 and cashed out her very small 401K balances from each employer in 2023 and 2024.  I know this reduces the $200 tax credit you can get for qualified retirement savings contributions.  The first one was deducted from the credit in her 2023 taxes.  The second will impact the 2024 tax credit.  Why does the amount received in 2023 impact 2024 taxes too?  Seems like you're being "punished repeatedly".  Am I doing this wrong?  The IRS website just states "...your eligible contributions may be reduced by any RECENT distributions you received from a retirement plan...".  Define RECENT.  GREATLY appreciate any clarification!!!

[DaveF1006]

It depends. According to IRS rules, "recent" distributions include those taken out of retirement accounts during a look-back period, which is designed to discourage people from cashing out their retirement savings while also contributing to such accounts. The look-back period includes:

1. The calendar year of the credit (e.g., 2024 for 2024 taxes),
2. The two calendar years prior (e.g., 2022 and 2023 for the 2024 Saver’s Credit),

So, even though the 2023 distribution was already accounted for on her 2023 taxes, it will also reduce her Saver’s Credit eligibility for her 2024 taxes because it falls within the two-year look-back window.

The IRS likely implemented this rule to prevent individuals from taking early withdrawals, cashing them out, and then quickly reinvesting the funds solely to claim the Saver's Credit multiple times. However, the rule can indeed feel like a "double penalty" for people like your daughter, who may not have cashed out for such reasons.

[dmertz]

The purpose of the credit is to promote saving for retirement.  Reducing the amount of new contributions that are considered when calculation the credit by the amount of recent distributions is an anti-abuse provision to prevent people from claiming the credit by funding new contributions with distributions and not actually increasing retirement savings.  Congress apparently figured that distributions within the two year prior the year for which this credit is being claimed are close enough in time to be considered to be assisting in funding the new contribution and made this restriction part of the tax code:  https://www.law.cornell.edu/uscode/text/26/25B#d_2