Many people who own a Roth IRA assume that there are no immediate tax advantages to be had by it. It is commonly known that Roth IRA’s provide great tax benefits at retirement age, but unlike traditional IRA’s, which allow you to deduct any contributions from your income, Roth IRA’s are after-tax dollars.
Still, there is a way that contributing to a Roth IRA can help your tax bill in the year that you contribute. This is known as the Retirement Savings Contribution Credit – and actually applies to contributions made to any sort of retirement savings account, including a Roth IRA. The credit can only be taken by those who made contributions to a retirement account in the tax year you are filing for, and the amount of the credit varies based on your income. Contributions include any amounts invested before April 15 of the following year. For example, if you put in $1,000 into a Roth IRA in February of 2005, you can still claim it on your 2004 tax return.
The Retirement Savings Contribution Credit is designed to reward low-income savers, and because of this the guidelines are somewhat limited as to who can claim it. The following guidelines apply: you may only take the credit if your AGI is less than $25,000, if you’re an individual, or less than $50,000 if you are married filing jointly. Furthermore, you may not take the credit if were born in 1987 or later, are claimed on someone else’s tax return as a dependent, or were a student. The IRS considers you a student if, during any five months of the tax year, were enrolled full-time at any school (not including night school, correspondence courses, or on-the-job training courses) or took a full-time, farm-training course given by the government.
Think you qualify? If you do, you will need to file IRS Form 8880, “Credit for Qualified Retirement Savings Contributions.” Thankfully, this is a relatively easy form to fill out. If you only made contributions to a Roth IRA during the previous tax year, put the amount on line 1 of Form 8880 (if you are married filing jointly, put your spouses information in the second column). Do not worry about line 2, as you only contributed to a Roth IRA. On line 4, total all of the distributions from the previous three years up until April 15th of the current year. So for, 2004 tax year, total all the distributions from 2002 until April 15th of 2005. These include any retirement distributions, even if you only contributed to a Roth IRA in the current year. Unless you are of retirement age or withdrew money for special purposes, you may not have to worry about this line. If you had any distributions, though, subtract line 4 from line 3 – if the total is zero or less you do not qualify for any credit.
However, if the number is greater than zero, write either the total or $2,000, whichever is less, on line 6, and total your line 6 and your spouses line 6 on line 7. Next you have to determine how much of a credit you’ll receive. Do this by putting your AGI (adjusted gross income, found on line 37 of form 1040 of line 22 of form 1040A) on line 8, and then consult the chart found in the publication. The credit is variable based on your income; for example, if you are married filing jointly, you can receive a 50% credit on your contributions if your AGI is $25,000 or less, with the percentage dwindling as your income increased up to $50,000. Multiply the total amount of line 7 with the appropriate percentage based on your income, and fill it in line 10.
Next, put the total amount of tax you owe on line 11 (from 1040, line 45 and form 1040A, line 28) and the number of other credits you are claiming (form 1040, lines 46-49 and form 1040A, lines 29-31 on line 12. If your other credits claimed are greater than the tax you owe, you will not qualify for this credit. If however, they are less, subtract line 12 from line 11 and put it on line 13. To determine your final retirement savings contribution credit, take the lesser of line 10 or line 13, and insert it into your federal tax return.
As always, if you have any questions about whether your contributions to a Roth IRA qualify for the credit, it is best to consult a tax professional or the IRS. Contributing to a Roth IRA does not necessarily disqualify you from tax breaks in the current year. The guidelines are strict, but if you take the time to learn if you qualify, you can save a lot of money on your taxes.
