Missed Tax Deductions for Roth IRA

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Saying Roth IRA contributions aren’t deductible only tells half of the story. There are other tax breaks you get when you contribute to a Roth IRA.

Roth IRA Refresher

With a Traditional IRA, you get a tax deduction when you make contributions but have to pay taxes when you take out money in retirement.

With a Roth IRA, you contribute money you already paid taxes on and don’t have to pay taxes when you take out money in retirement.

Another advantage of both types of IRAs is that you don’t have to pay taxes on investment earnings inside of your IRA. That means no tax on dividends and no tax on capital gains.

Roth IRA Saver’s Credit

While you can’t deduct Roth IRA contributions, you may be able to claim the Saver’s Credit based on your Roth IRA contributions. A tax credit is even better than a tax deduction because it directly reduces your taxes owed instead of just lowering your taxable income.

To be eligible for the Saver’s Credit (also known as the Retirement Savings Contributions Credit), you need to be:

  • At least 18
  • Not claimed as someone else’s dependent
  • Not be a student (defined as being enrolled full-time for at least 5 months during the year)

If you’re eligible, the credit is good for your first $2,000 in Roth IRA contributions.

Income limits also apply.

  • You get 50% of your Roth IRA contributions (maximum credit of $1,000), if your AGI is up to $21,750 as a single filer or $43,500 as a joint filer.
  • You get 20% of your contributions (maximum credit of $400), if your AGI is up to $23,750 as a single filer or $47,500 as a joint filer.
  • You get 10% (maximum $200), if your AGI is up to $36,500 as a single filer or $73,000 as a joint filer.

Remember that your AGI is your income after above-the-line tax deductions and business expenses. So you can still qualify even if your annual salary or gross income is higher.

You can also use traditional IRA or 401(k) contributions to lower your AGI to get the Saver’s Credit. Ask a tax pro for details.

Tax Benefits in Retirement

When you retire, having a Roth IRA can also help reduce your taxes on other types of income. This includes your Social Security, pension, traditional IRA withdrawals, and 401(k) withdrawals.

Your Social Security benefits may or may not be taxable depending on your total taxable income for each year. Roth IRA withdrawals don’t count as income, but other types of retirement withdrawals do. So having a Roth IRA can help you avoid taxes on your Social Security.

Pension payments, traditional IRA withdrawals, and 401(k) withdrawals are typically always taxable. However, the taxes are based on your tax bracket.

Roth IRA withdrawals do not increase your tax bracket. So by having some of your savings in a Roth IRA, you can keep yourself in a lower tax bracket and pay less taxes on your other retirement income.

Required Minimum Distributions

Don’t forget Required Minimum Distributions for Traditional IRAs or 401(k)s.

Starting at age 72, you’re required to start taking withdrawing money based on your expected life expectancy. The IRS forces you to empty out your tax-deferred accounts and pay taxes rather than leaving the money in and not paying taxes.

RMDs can really increase your taxes since you’ll also be taking Social Security and maybe a pension at that age. If you delay your Social Security to get a larger monthly payment, your income (and taxes) will be even higher.

Since you already paid taxes on your Roth IRA, there are no RMDs from your Roth IRA. In addition, RMDs are only based on your traditional IRA and 401(k) balances, so saving money in a Roth IRA instead lowers your potential RMDs.

Early Withdrawals from Retirement Accounts

Another thing that people often don’t plan for but probably should is needing to take out IRA money early. Even if you expect the money to be for retirement, things happen.

You might need a larger down payment to buy a house, have a medical emergency, or unexpectedly lose your job.

You can take out Roth IRA contributions at any time without taxes or penalties. On the other hand, an early withdrawal from a Traditional IRA or 401(k) is always taxable even if you have a qualifying reason that lets you avoid the early withdrawal penalty.

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