Roth IRAs are primarily used for retirement planning, but the flexibility inherent in a Roth IRA lends itself to shorter-term financial planning. Tax filers with earned income under certain levels can receive a tax credit for funding a Roth account. The Credit for Qualified Retirement Savings Contributions, often referred to as simply the saver's credit, may be claimed for a Roth IRA contribution.
Depending on your income level, the saver's credit can be as much as 50 percent of your contribution to a Roth IRA. A unique aspect of a Roth IRA is that you can withdraw the contribution portion in any later year without penalty. Interest earned on a Roth IRA, however, cannot be withdrawn early without incurring a penalty.
The strategy of funding a Roth IRA with the goal of also claiming the saver's credit is sometimes of limited use. If you withdraw the contributions in the following year, your ability to claim the saver's credit again for that year is reduced by the amount of the withdrawal.
Individuals Excluded From Claiming the Credit
To contribute to a Roth IRA, you must have earned income equal to or greater than the amount of the contribution. The tax rules are designed to prevent younger workers who might be included on a parent's tax return from claiming the saver's credit. Tax filers who are not eligible for the saver's credit include:
- Workers claimed as a tax dependent
- Full-time students
- Workers under age 18
Ordering Rule for Distributions
It's fairly easy to ensure that future withdrawals from a Roth IRA consist only of your contributions and not earnings. There is an ordering rule for Roth IRA distributions that states that contributions are considered to be received first and earnings are received last.
For one person, the maximum amount of Roth IRA contributions eligible for the credit is $2,000. A Roth IRA can be funded up until the due date of the tax return for the applicable year. The extended deadline allows you time to determine the potential impact of the saver's credit before proceeding with Roth IRA funding.
The saver's credit cannot be refunded if it exceeds your tax due. If you are funding a Roth IRA with the primary purpose of claiming the saver's credit, you might need to adjust your contribution to maximize tax savings. Contact a financial planner for more information on the many advantages of a Roth IRA.