November 23, 2010

Is a Roth IRA the Right Choice for the Williams'?

Mr and Mrs Williams currently make salaries of $30,000 each and both of them work full time.   They have $110,000 in retirement and they are in their early 30's.   They have one child and Mrs Williams is pregnant and expecting their 2nd child halfway through the year.  She will stop working for the second half of the year and stay home with their kids after that.   Combined they will end up making $45,000 from Mr Williams $30,000 salary and half a years worth of Mrs Williams $30,000 income.   Mr. Williams will qualify for a pension and Mrs Williams 

Should they put their retirement into a Roth IRA or a traditional IRA?

They have take home total wages of $45,000.  The standard deduction for a married couple is $11,400.   They have four exemptions for the year for $3,650 each or $14,600 total.   This makes their taxable income $19,000 total.    The tax due on that amount is $2,013.   However they will have two children which will give them two child tax credits of $1000 each for total of $2,000 in tax credit.   The Williams should fill out form 8880 because they would also qualify for a credit for their retirement savings.  People in lower income levels who put money into a Roth or traditional IRA can qualify for 10% to 50% credit on the first $2000 of contributions.   The Williams barely qualify as their income is at the top of what does qualify.   But they do get the 10% credit on the first $2000 from each.  That would give them a up to $400 in credit. With a tax bill of $2,013 and credits of $2000 and up to $400 they can effectively eliminate their entire income tax liability.

Zero Taxes Makes Roth IRA a Winner

They are paying NO income taxes this year.      This one is a no brainer.  The Roth IRA is a virtual no lose situation for them given their current tax situation.   They should definitely lock in the 0% tax rate now on their retirement savings.   Going with a traditional IRA would be a bad choice because they would save nothing today and then potentially owe taxes on the money after retirement.

Summary:    The Williams family has $45,000 income this year with two children.   They will pay no income taxes given their situation.   Roth IRA is a definite right choice anyone with zero income tax liability.

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