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Roth Individual Retirement Accounts (IRAs) are not for people who want their tax breaks immediately. Instead, you generally have to wait until retirement to see the significant tax savings granted by the after-tax savings model of Roth IRAs. Knowing how much you will save in the future can make it easier to wait.
No Deduction for Roth IRA Contributions
Roth IRAs do not allow you to deduct a contribution to the account no matter your income level, filing status, age or whether you have an employer-sponsored retirement plan. Roth IRAs offer after-tax savings, which means you have to contribute money that you do not get to write off on your taxes. The only way that a Roth IRA contribution can lower your taxes is with the retirement savings credit. However, Roth IRAs save you money on your taxes in other ways.
Retirement Savings Credit
You won't be able to deduct your Roth IRA contributions, but you can still use money contributed to a Roth IRA to count towards the Retirement Savings Credit. However, you must meet several qualifications, including being over 18, not a full-time student and having adjusted gross income under fairly restrictive limits. As of 2011, the IRS sets the limits at $27,750 for singles, $41,625 for heads of household and $55,500 for married couples filing a joint return. The limit for married filing separately is the same as singles. The maximum you can save with the Retirement Savings Credit is $1,000 of filing a single return or $2,000 if filing a joint return. Since this is a credit, you lower your taxes directly rather than just lowering your taxable income.
Roth IRA Gains
Roth IRA contributions can grow without being subjected to annual income taxes or capital-gains taxes while they remain in the account. For example, if one year you fall in the 15 percent capital-gains tax rate and your Roth IRA has $8,000 in capital gains, you avoid paying $1,200 in taxes. If you have $2,000 in interest one year in your Roth IRA that would otherwise be taxed as regular income in a 31 percent bracket, you would save $620 by having the money in the Roth IRA.
Qualified Roth IRA Distributions
To take a qualified distribution from your Roth IRA, the account must be five tax years old and you must be over 59 1/2 years old. When you meet the requirements, you can withdraw the entire amount tax-free whenever you want. To figure the amount the tax-free distribution from your Roth IRA saves you, estimate your tax rate at retirement and multiply it by the amount you will withdraw. For example, if you anticipate paying 24 percent income taxes at retirement and taking annual distributions of $30,000, multiply 0.24 by $30,000 to estimate your tax savings on the withdrawals to be $7,200.
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