Are Roth IRA contributions tax deductible?
The simple answer is no. But a more nuanced answer will note that although Roth IRA contributions themselves are not tax deductible, you can claim a Roth IRA tax credit or a claim a loss on a Roth IRA if eligible.
So let’s take a look at the various options at your disposal.
Non-Deductible Roth IRA Contributions
Unlike 401k or Traditional IRA contributions, Roth IRA contributions are not tax deductible. According to the Roth IRA funding rules established by the IRS, all your contributions must be made with after-tax dollars.
For example, let’s say you earn $40,000, and you’re in the 25% tax bracket. If you want to make a $5,500 tax deductible 401k contribution, you’ll put $5,500 in your 401k first and then you pay your taxes, which leaves you with $25,875 (75% of $34,500).
However, if you make a $5,500 non-deductible Roth IRA contribution, you’ll pay your taxes first, which leaves you with $30,000 (75% of $40,000). Then you’ll make your $5,500 Roth IRA contribution, leaving you with $24,500 in disposable income.
However, just because your Roth IRA contributions aren’t tax deductible, it doesn’t mean you can’t take advantage of certain provisions which provide a benefit similiar to tax deductibility.
Yes, you can potentially still get a tax benefit by using a Roth IRA. How is this possible?
The Roth IRA Saver’s Tax Credit
While your Roth IRA contributions are not tax deductible, you can claim a Roth IRA tax credit on IRS Form 8880 of up to 50% on your first $2,000 in Roth IRA contributions if your income falls within the predetermined income limits. This tax credit is called the Saver’s Tax Credit.
You can receive a 50% tax credit on your first $2,000 in Roth IRA contributions if you’re:
- Single and earn $17,750 or less
- Married filing jointly and earn $35,500 or less
- Head of Household and earn $26,625 or less
You can receive a 20% tax credit on your first $2,000 in Roth IRA contributions if you’re:
- Single and earn between $19,250 and $17,751
- Married filing jointly and earn between $38,500 and $35,501
- Head of Household and earn between $28,875 and $26,626
You can receive a 10% tax credit on your first $2,000 in Roth IRA contributions if you’re:
- Single and earn between $29,500 and $19,251
- Married filing jointly and earn between $59,000 and $38,501
- Head of Household and earn between $44,250 and $28,876
Where to Open a Roth IRA
Opening a Roth IRA is always a good idea, but if you fall into one of the above income categories then going without a Roth IRA is costing you a big tax break. The beautiful thing about tax credits is they are a direct reduction in the amount of tax you owe; tax deductions only lower your taxable income.
If you can benefit from funding a Roth IRA and getting a Saver’s Tax Credit, here are some great places to open an account.
If you are just starting out investing there is one broker that was built for you: ShareBuilder.
ShareBuilder is all about setting up good investing habits. Instead of offering overwhelming trade charts and confusing interfaces, the company focuses on helping you automatically invest your funds each month at rock bottom prices. If you invest automatically trades can be as low as $4 per month.
Open a Roth IRA account with ShareBuilder and get your Saver’s Tax Credit this year.
If you don’t want to have to pick specific investments then Betterment is a great choice to open a Roth IRA with. The company makes investing incredibly simple: you just select how much risk you can handle on a sliding scale, and the actual investment mix is taken care of by the company.
The risk-averse investor gets a basket of pre-selected lower risk bond ETFs and the investor wanting higher returns gets a basket of pre-selected stock ETFs. (If you select a 60% stock and 40% bond mix, the investments adjust automatically for you.)
Open a Roth IRA account with Betterment and get your Saver’s Tax Credit this year.
Scottrade is a great place to open a Roth IRA. You get inexpensive trades, fantastic customer service, an easy to use online interface, and the ability to talk with someone in person. Scottrade has over 500 physical branch locations around the country so if you ever get stuck you can drive in to the closest branch to get help.
Open a Roth IRA account with Scottrade and get your Saver’s Tax Credit this year.
Two Good Financial Cents Resources for Opening a Roth IRA
Still not sure where to open an account. Don’t worry, we’ve created a set of resources for you to help guide you in your decision.
- Best Places to Open a Roth IRA: This is a breakdown of some of the best brokers to open up a Roth IRA with. You’ll find out about the benefits of each broker as well as some of the costs in terms of trades, account maintenance, and the minimum deposit needed to open an account.
- Best Online Stock Broker Sign Up Bonuses: Online stock brokers are willing to give you cold hard cash or pricey electronics to sway your decision when opening up an account. This is a list of all the current sign up offers. You might be surprised at how much you can get for your account.
Claiming Roth IRA Losses
And while your Roth IRA contributions are not tax deductible, you can claim Roth IRA losses under certain circumstances. Just remember that only a loss of your original Roth IRA contributions constitutes a loss, not simply a declining balance.
For instance, if you’ve contributed $25,000 to your Roth IRA over the years, but your account is now worth only $20,000, then you’ve experienced a $5,000 loss. But if you’ve contributed $25,000 over the years, and your Roth IRA balance declines to $50,000 from $60,000 one year ago, this is not considered a loss. It’s considered a $25,000 gain.
Assuming you’ve experienced a real loss in your Roth IRA, you are able to claim that loss on your tax return, but only if all of the following apply:
- You close all of your Roth IRA accounts
- You claim your loss on an itemized tax return
- The loss exceeds 2% of your Adjustable Gross Income (AGI), and
- You’re not subject to the Alternative Minimum Tax (AMT)
Assuming your situation meets each of the above factors, you’re eligible to claim a loss on your tax return, but only the amount above 2% of your Adjustable Gross Income (AGI) is tax deductible. Let’s take a more in-depth look at each factor:
- You Close All Roth IRA Accounts – To claim a loss, you must close every Roth IRA account in your name, withdrawing every dollar. For instance, let’s say you have one Roth IRA account with E*TRADE and another with Scottrade. If you’ve experience a loss in one account, you can’t just close that account and claim the loss. You must close both accounts.
- You File An Itemized Return – In order to claim a Roth IRA loss, you must file an itemized tax return and claim the loss on Schedule A – Itemized Deductions (Form 1040). Do not claim the loss on Schedule D – Capital Gains and Losses. This is a common mistake, because it just seems like the proper place to report a loss on your investments, but it’s not. On Schedule A, your loss goes in the category “Miscellaneous Deduction”.
- Your Loss Exceeds 2% Of Your AGI – It’s not enough to simply lose money, your loss must exceed 2% of your Adjustable Gross Income (AGI) in order for you to claim it. For instance, if you have a $500 loss, but $50,000 in AGI, you can NOT claim a loss. Why? Because $500 is only 1% of your AGI, but a $1,500 loss can be claimed because it’s 3% of your AGI.
- You’re Not Subject To The AMT – If you’re subject to the Alternative Minimum Tax (AMT), you can’t claim a loss. Why? Because in order to claim a loss, you must do so as a “Miscellaneous Deduction” on Schedule A (Form 1040), and Schedule A Miscellaneous Deductions are NOT deductible if you’re subject to the AMT.
Once you’re satisfied that you meet the requirements necessary to claim a Roth IRA loss on your tax return, you’re free to deduct any amount above 2% of your Adjustable Gross Income (AGI). For instance, suppose you have a $100,000 AGI, and you claim a $4,500 Roth IRA loss. How much are you able to deduct? $2,500. Why? Because only the amount above 2% is deductible, so you’re not able to claim the first $2,000 of your loss, only the remaining $2,500.
This is a guest post by Britt who writes for Your-Roth-IRA.com, a website which looks to educate people concerning the Roth IRA rules and regulations.
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