I searched and didn't see anything on this topic. I am not very slick with the search feature and seem to always get a lot of unrelated posts in my results. I've seen a lot of Roth vs Traditional threads, but I don't remember any that took in to account this credit. Most on this board probably make enough in earned income that they've never considered the impact of traditional 401k/403b contributions on the earned income credit. This is something my girlfriend is running in to. So I wanted to see if anyone has any thoughts or opinions.
Some background to the question:
My girlfriend makes about 35K/yr. She has a 403b available through her employer to which she can contribute as traditional or as Roth. She is firmly in the 15% tax bracket. She has one kid and alternates taking the dependent exemption and child tax credit with her ex-husband. She files head-of-household (HoH) and gets the earned income tax credit (EIC) even in years when she cannot claim the dependent. Because of all this, she pays relatively little in taxes.
Generally, it would be obvious that she'd want to do any retirement savings as Roth contributions. However, the tax savings of the traditional 403b is greater than the 15% associated with the tax bracket. The Earned Income Credit adds another ~15% to the tax reduction. Every hundred dollars she puts in to traditional 403b reduces her tax bill by 31 dollars.
If she puts in enough to reduce AGI to the 20% threshold of the Savers Credit, it has a 34% reduction on income taxes paid. If she gets the savers credit to the 50% level it has a 41% reduction in current year tax paid.
Because the Earned Income Credit is refundable, it is still a 31 or 34% difference even after the tax liability is 0. There is a point where Uncle Sam is paying her 31 dollars for every 100 dollars she puts in the traditional 403b and she pays zero taxes.
Because she is currently filing as HoH and getting the EIC, it is unlikely she will ever be paying less taxes as a percentage of gross income than she is right now. When the child, currently 11, grows up she'll likely be filing single with no significant tax credits or deductions. That makes the Roth contributions seems like the clear winner. However, she'll be forgoing a 31% "match" from the federal government if she does the Roth.
Should she be looking at this as if she's avoiding a 31% tax bracket and contribute to traditional? Or should she ignore the credits and go with Roth under the premise that she is probably paying less in taxes now than she will in the future? Theoretically she could contribute the 31% savings to a Roth IRA or increase her traditional savings by 31% and see no difference in take-home pay. Whether she would do that in practice, I can't say.
Any thoughts would be appreciated.
All of the above figures are based on 2014 tax rates and credit thresholds.
Some background to the question:
My girlfriend makes about 35K/yr. She has a 403b available through her employer to which she can contribute as traditional or as Roth. She is firmly in the 15% tax bracket. She has one kid and alternates taking the dependent exemption and child tax credit with her ex-husband. She files head-of-household (HoH) and gets the earned income tax credit (EIC) even in years when she cannot claim the dependent. Because of all this, she pays relatively little in taxes.
Generally, it would be obvious that she'd want to do any retirement savings as Roth contributions. However, the tax savings of the traditional 403b is greater than the 15% associated with the tax bracket. The Earned Income Credit adds another ~15% to the tax reduction. Every hundred dollars she puts in to traditional 403b reduces her tax bill by 31 dollars.
If she puts in enough to reduce AGI to the 20% threshold of the Savers Credit, it has a 34% reduction on income taxes paid. If she gets the savers credit to the 50% level it has a 41% reduction in current year tax paid.
Because the Earned Income Credit is refundable, it is still a 31 or 34% difference even after the tax liability is 0. There is a point where Uncle Sam is paying her 31 dollars for every 100 dollars she puts in the traditional 403b and she pays zero taxes.
Because she is currently filing as HoH and getting the EIC, it is unlikely she will ever be paying less taxes as a percentage of gross income than she is right now. When the child, currently 11, grows up she'll likely be filing single with no significant tax credits or deductions. That makes the Roth contributions seems like the clear winner. However, she'll be forgoing a 31% "match" from the federal government if she does the Roth.
Should she be looking at this as if she's avoiding a 31% tax bracket and contribute to traditional? Or should she ignore the credits and go with Roth under the premise that she is probably paying less in taxes now than she will in the future? Theoretically she could contribute the 31% savings to a Roth IRA or increase her traditional savings by 31% and see no difference in take-home pay. Whether she would do that in practice, I can't say.
Any thoughts would be appreciated.
All of the above figures are based on 2014 tax rates and credit thresholds.
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