Roth 401k or Traditional?

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channtheman
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Joined: Wed Dec 06, 2017 7:32 am

Roth 401k or Traditional?

Post by channtheman » Thu Sep 20, 2018 3:09 pm

I make ~61,000 per year. My wife stays at home with 1 child. We are planning at least 1 more child in the next 3 years. Depending on how that labor/delivery goes, we may have more.

I'm currently investing 12% into my traditional 401k. My company matches 50% up to 6% so essentially 3%.

I believe my current federal tax liability is appx. $1,171. If I invested in a roth instead, my federal tax liability would be appx. $2,059. I am unsure at this point if traditional vs roth has much if any effect on state taxes (Arizona).

Does it make sense to invest in the roth 401k instead of the traditional, given my very low tax liability? If we have more kids, I would potentially have no tax liability, correct? Is there anything I am missing?

Thanks in advance, bogleheads. I've learned a lot from reading these forums.

bradpevans
Posts: 330
Joined: Sun Apr 08, 2018 1:09 pm

Re: Roth 401k or Traditional?

Post by bradpevans » Thu Sep 20, 2018 3:18 pm

Roth vs. Traditional is largely a matter of "tax rate in vs. tax rate out"

Traditional "saves" you that rate now, but you "pay" some rate to get the money out.

Roth you "pay" your (known) rate now, but you never pay again.

For most, the traditional is better due to progressive tax rates:
you "save" the highest rate on all the money in
you pay progressive rates on money out

KlangFool
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Joined: Sat Oct 11, 2008 12:35 pm

Re: Roth 401k or Traditional?

Post by KlangFool » Thu Sep 20, 2018 3:22 pm

channtheman wrote:
Thu Sep 20, 2018 3:09 pm
I make ~61,000 per year. My wife stays at home with 1 child. We are planning at least 1 more child in the next 3 years. Depending on how that labor/delivery goes, we may have more.

I'm currently investing 12% into my traditional 401k. My company matches 50% up to 6% so essentially 3%.

I believe my current federal tax liability is appx. $1,171. If I invested in a roth instead, my federal tax liability would be appx. $2,059. I am unsure at this point if traditional vs roth has much if any effect on state taxes (Arizona).

Does it make sense to invest in the roth 401k instead of the traditional, given my very low tax liability? If we have more kids, I would potentially have no tax liability, correct? Is there anything I am missing?

Thanks in advance, bogleheads. I've learned a lot from reading these forums.
channtheman,

You are missing one key item: tax credit:

https://www.bogleheads.org/wiki/Saver%27s_credit

If you contribute enough to Trad. 401K, you may qualify for saver's credit. In those cases, you may get a tax refund even though you pay zero taxes.

KlangFool

channtheman
Posts: 8
Joined: Wed Dec 06, 2017 7:32 am

Re: Roth 401k or Traditional?

Post by channtheman » Thu Sep 20, 2018 4:05 pm

KlangFool wrote:
Thu Sep 20, 2018 3:22 pm
channtheman,

You are missing one key item: tax credit:

https://www.bogleheads.org/wiki/Saver%27s_credit

If you contribute enough to Trad. 401K, you may qualify for saver's credit. In those cases, you may get a tax refund even though you pay zero taxes.

KlangFool
I had completely forgotten about the saver's credit. It looks like with my current 401k contributions of $7,400 my AGI is $53,600. That puts us in the 10% bracket and means we could apply for a credit of $740 on our tax return, correct? Just want to make sure I'm interpreting this correctly and my math is right.

KlangFool
Posts: 10190
Joined: Sat Oct 11, 2008 12:35 pm

Re: Roth 401k or Traditional?

Post by KlangFool » Thu Sep 20, 2018 4:14 pm

channtheman wrote:
Thu Sep 20, 2018 4:05 pm
KlangFool wrote:
Thu Sep 20, 2018 3:22 pm
channtheman,

You are missing one key item: tax credit:

https://www.bogleheads.org/wiki/Saver%27s_credit

If you contribute enough to Trad. 401K, you may qualify for saver's credit. In those cases, you may get a tax refund even though you pay zero taxes.

KlangFool
I had completely forgotten about the saver's credit. It looks like with my current 401k contributions of $7,400 my AGI is $53,600. That puts us in the 10% bracket and means we could apply for a credit of $740 on our tax return, correct? Just want to make sure I'm interpreting this correctly and my math is right.
channtheman,

I am not sure. Could someone else please verify this?

KlangFool

MrBeaver
Posts: 228
Joined: Tue Nov 14, 2017 4:45 pm

Re: Roth 401k or Traditional?

Post by MrBeaver » Thu Sep 20, 2018 4:16 pm

channtheman wrote:
Thu Sep 20, 2018 4:05 pm
KlangFool wrote:
Thu Sep 20, 2018 3:22 pm
channtheman,

You are missing one key item: tax credit:

https://www.bogleheads.org/wiki/Saver%27s_credit

If you contribute enough to Trad. 401K, you may qualify for saver's credit. In those cases, you may get a tax refund even though you pay zero taxes.

KlangFool
I had completely forgotten about the saver's credit. It looks like with my current 401k contributions of $7,400 my AGI is $53,600. That puts us in the 10% bracket and means we could apply for a credit of $740 on our tax return, correct? Just want to make sure I'm interpreting this correctly and my math is right.
The saver's credit percentage benefit only extends to $2000 of contributions per tax filer (so $4000 if MFJ). So your maximum benefit would be $400, not $740. It looks like it would be hard to get to the 41k 20% benefit range, which would give you an additional $400, or to 38k which would give you an additional $1600. As is, if you went all Roth, if you stayed below 63k then you would still get the $400 saver's credit.

MrBeaver
Posts: 228
Joined: Tue Nov 14, 2017 4:45 pm

Re: Roth 401k or Traditional?

Post by MrBeaver » Thu Sep 20, 2018 4:18 pm

One more thing to check: while the child tax credit has been increased, not all of it is refundable. As a result, maximizing the saver's credit with children could result in no actual benefit, since your total credits might exceed your tax liability.

channtheman
Posts: 8
Joined: Wed Dec 06, 2017 7:32 am

Re: Roth 401k or Traditional?

Post by channtheman » Thu Sep 20, 2018 6:52 pm

MrBeaver wrote:
Thu Sep 20, 2018 4:16 pm
channtheman wrote:
Thu Sep 20, 2018 4:05 pm
KlangFool wrote:
Thu Sep 20, 2018 3:22 pm
channtheman,

You are missing one key item: tax credit:

https://www.bogleheads.org/wiki/Saver%27s_credit

If you contribute enough to Trad. 401K, you may qualify for saver's credit. In those cases, you may get a tax refund even though you pay zero taxes.

KlangFool
I had completely forgotten about the saver's credit. It looks like with my current 401k contributions of $7,400 my AGI is $53,600. That puts us in the 10% bracket and means we could apply for a credit of $740 on our tax return, correct? Just want to make sure I'm interpreting this correctly and my math is right.
The saver's credit percentage benefit only extends to $2000 of contributions per tax filer (so $4000 if MFJ). So your maximum benefit would be $400, not $740. It looks like it would be hard to get to the 41k 20% benefit range, which would give you an additional $400, or to 38k which would give you an additional $1600. As is, if you went all Roth, if you stayed below 63k then you would still get the $400 saver's credit.
Ahh, yes, I see what you are saying. I misinterpreted what I read.

As for your last sentence, the saver's credit doesn't care if your contributions are roth or traditional?

Edit: Apologies, I was in a rush and after I went back and read the wiki on the saver's credit again, I see it is traditional or roth.
Last edited by channtheman on Thu Sep 20, 2018 7:01 pm, edited 1 time in total.

channtheman
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Joined: Wed Dec 06, 2017 7:32 am

Re: Roth 401k or Traditional?

Post by channtheman » Thu Sep 20, 2018 7:00 pm

MrBeaver wrote:
Thu Sep 20, 2018 4:18 pm
One more thing to check: while the child tax credit has been increased, not all of it is refundable. As a result, maximizing the saver's credit with children could result in no actual benefit, since your total credits might exceed your tax liability.
Good point. The saver's credit is non-refundable. How much of the child tax credit is refundable?

banhbao
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Re: Roth 401k or Traditional?

Post by banhbao » Thu Sep 20, 2018 7:56 pm

You didn't state how long you have until retirement, which I believe is an important consideration.

Because with the Roth (as long as you follow the rules), you won't pay taxes at all on the interest/dividends/capital gains. So if you invest wisely and earn a lot of compound interest over the years, your initial investment could be multiplied a few times over and you'd get all that tax-free.

But with the traditional IRA, you'll have to pay taxes on the interest.

If you're young I'd rather pay taxes on $5,500 now rather than $20,000 later.

MotoTrojan
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Re: Roth 401k or Traditional?

Post by MotoTrojan » Thu Sep 20, 2018 8:01 pm

banhbao wrote:
Thu Sep 20, 2018 7:56 pm
You didn't state how long you have until retirement, which I believe is an important consideration.

Because with the Roth (as long as you follow the rules), you won't pay taxes at all on the interest/dividends/capital gains. So if you invest wisely and earn a lot of compound interest over the years, your initial investment could be multiplied a few times over and you'd get all that tax-free.

But with the traditional IRA, you'll have to pay taxes on the interest.

If you're young I'd rather pay taxes on $5,500 now rather than $20,000 later.
This is wrong. While dollar for dollar there is a difference ($1 in a Roth is worth more than $1 in a 401k), the Roth obviously costs more to get a $1 into it.

Let's take the limit out of the equation and say the OP can afford to invest $5000 into their 401k, in pre-tax terms. With the same change in take-home pay they could get perhaps $4000 into a Roth (20% tax). Both go up 10x over their long retirement. Assuming tax-bracket is the same as now, they will have the same after-tax amount in retirement; ie Roth grows to $40,000 and no tax taken out, traditional grows to $50,000 and they pay $10,000 in tax.

Of course they may not be in the same tax-bracket, so that is another story.

Safest bet is to diversify and have some pretax and some post-tax 401k/IRA assets.

banhbao
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Joined: Mon Sep 10, 2018 7:54 pm

Re: Roth 401k or Traditional?

Post by banhbao » Thu Sep 20, 2018 8:25 pm

MotoTrojan wrote:
Thu Sep 20, 2018 8:01 pm
banhbao wrote:
Thu Sep 20, 2018 7:56 pm
You didn't state how long you have until retirement, which I believe is an important consideration.

Because with the Roth (as long as you follow the rules), you won't pay taxes at all on the interest/dividends/capital gains. So if you invest wisely and earn a lot of compound interest over the years, your initial investment could be multiplied a few times over and you'd get all that tax-free.

But with the traditional IRA, you'll have to pay taxes on the interest.

If you're young I'd rather pay taxes on $5,500 now rather than $20,000 later.
This is wrong. While dollar for dollar there is a difference ($1 in a Roth is worth more than $1 in a 401k), the Roth obviously costs more to get a $1 into it.

Let's take the limit out of the equation and say the OP can afford to invest $5000 into their 401k, in pre-tax terms. With the same change in take-home pay they could get perhaps $4000 into a Roth (20% tax). Both go up 10x over their long retirement. Assuming tax-bracket is the same as now, they will have the same after-tax amount in retirement; ie Roth grows to $40,000 and no tax taken out, traditional grows to $50,000 and they pay $10,000 in tax.

Of course they may not be in the same tax-bracket, so that is another story.

Safest bet is to diversify and have some pretax and some post-tax 401k/IRA assets.
Ah, you're right. It's based on the expected tax rate in the future. If you expected a higher rate upon retirement it might be a better deal to go with the Roth. But otherwise you should go with the traditional.

MotoTrojan
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Re: Roth 401k or Traditional?

Post by MotoTrojan » Thu Sep 20, 2018 8:41 pm

banhbao wrote:
Thu Sep 20, 2018 8:25 pm
MotoTrojan wrote:
Thu Sep 20, 2018 8:01 pm
banhbao wrote:
Thu Sep 20, 2018 7:56 pm
You didn't state how long you have until retirement, which I believe is an important consideration.

Because with the Roth (as long as you follow the rules), you won't pay taxes at all on the interest/dividends/capital gains. So if you invest wisely and earn a lot of compound interest over the years, your initial investment could be multiplied a few times over and you'd get all that tax-free.

But with the traditional IRA, you'll have to pay taxes on the interest.

If you're young I'd rather pay taxes on $5,500 now rather than $20,000 later.
This is wrong. While dollar for dollar there is a difference ($1 in a Roth is worth more than $1 in a 401k), the Roth obviously costs more to get a $1 into it.

Let's take the limit out of the equation and say the OP can afford to invest $5000 into their 401k, in pre-tax terms. With the same change in take-home pay they could get perhaps $4000 into a Roth (20% tax). Both go up 10x over their long retirement. Assuming tax-bracket is the same as now, they will have the same after-tax amount in retirement; ie Roth grows to $40,000 and no tax taken out, traditional grows to $50,000 and they pay $10,000 in tax.

Of course they may not be in the same tax-bracket, so that is another story.

Safest bet is to diversify and have some pretax and some post-tax 401k/IRA assets.
Ah, you're right. It's based on the expected tax rate in the future. If you expected a higher rate upon retirement it might be a better deal to go with the Roth. But otherwise you should go with the traditional.

Yup. Things to keep in mind:
If you save a LOT in pretax assets, your RMDs could force you into higher tax brackets than you'd actually intend to spend (can just reinvest those assets in taxable). Also keep in mind marginal tax-rate is only part of the equation. If your only income was 401k pre-tax and post-tax (Roth) assets, you'd want to have some of each so you could fill up the lower (potentially 0%) brackets with pre-tax assets, before switching to Roth.

Again, for many situations it is good to have both. I am fortunate to be able to fully fund a Roth IRA and a pre-tax 401k, giving me good diversity (plus some taxable assets).

MotoTrojan
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Re: Roth 401k or Traditional?

Post by MotoTrojan » Thu Sep 20, 2018 8:43 pm

OP, not familiar with state taxes, but a 401k would prevent you paying any if applicable. This can be another reason to go traditional, if you live in a high-state tax but plan to retire somewhere with no/lower income tax.

For example someone making $100K in CA could save ~9% income tax by using a traditional 401k, then retire in Florida and get a 9% increase in after-tax wealth.

billfromct
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Re: Roth 401k or Traditional?

Post by billfromct » Fri Sep 21, 2018 12:06 am

Under the IRS heading, "Retirement Savings Contributions Credit (Saver's Credit)", under "Amount of the Credit", the IRS says:

"The maximum credit amount is $2,000 ($4,000 if married filing jointly)."

It does not say that the benefit only extends to a $2,000 or $4,000 (if married filing jointly) contribution.

Until now, I also thought the $2,000 (single) & $4,000 (married filing jointly) figure was the maximum contribution amount that the tax credit was calculated on.

MrBeaver, or anyone else, can you verify (IRS wise) that the Saver's Credit is calculated on a maximum of $2,000 (single) or $4,000 (married filing jointly) contribution figure?

I checked "the Google", every link that I looked at (3 or 4) also indicated that the Saver's Credit was based on the $2,000 or $4,000 contribution figure. Did the IRS mis-speak on their website? I couldn't open up IRS form 8880 on my tablet due to memory capacity issues.

The reason I would like verification is that I may gift money to a friend so she can contribute to an IRA to get the maximum Saver's Credit.

bill
Last edited by billfromct on Fri Sep 21, 2018 2:34 am, edited 1 time in total.

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FiveK
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Re: Roth 401k or Traditional?

Post by FiveK » Fri Sep 21, 2018 12:37 am

billfromct wrote:
Fri Sep 21, 2018 12:06 am
...can you verify (IRS wise) that the Saver's Credit is calculated on a maximum of $2,000 (single) or $4,000 (married filing jointly) contribution figure?
Yes, that is correct. See line 6 of Form 8880.

channtheman
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Re: Roth 401k or Traditional?

Post by channtheman » Fri Sep 21, 2018 1:54 pm

banhbao wrote:
Thu Sep 20, 2018 7:56 pm
You didn't state how long you have until retirement, which I believe is an important consideration.

Because with the Roth (as long as you follow the rules), you won't pay taxes at all on the interest/dividends/capital gains. So if you invest wisely and earn a lot of compound interest over the years, your initial investment could be multiplied a few times over and you'd get all that tax-free.

But with the traditional IRA, you'll have to pay taxes on the interest.

If you're young I'd rather pay taxes on $5,500 now rather than $20,000 later.
I'm 27 and have a long ways to go until retirement. In doing some calculations last night with my wife, I was leaning towards a couple thousand in the traditional to lower my AGI to ensure saver's credit eligibility, and then putting the rest into the roth.

MrBeaver
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Re: Roth 401k or Traditional?

Post by MrBeaver » Fri Sep 21, 2018 3:28 pm

FiveK wrote:
Fri Sep 21, 2018 12:37 am
billfromct wrote:
Fri Sep 21, 2018 12:06 am
...can you verify (IRS wise) that the Saver's Credit is calculated on a maximum of $2,000 (single) or $4,000 (married filing jointly) contribution figure?
Yes, that is correct. See line 6 of Form 8880.
Yep. For this reason, the middle zone of the saver's credit is basically worthless. At 38k AGI (MFJ), the benefit can be $2000. At 41k AGI (top of the 20% zone) the benefit is reduced to $800. Essentially, if you are saving $4000 for retirement as a married couple and your ending tax liability is more than $0, your marginal tax rate from 38k to 41k of AGI is 38.6%.

In general with the saver's credit, you will get the most benefit by reducing your AGI below the lowest threshold (38k MFJ), or hit the top of the highest threshold (63k).
channtheman wrote:
Thu Sep 20, 2018 7:00 pm
MrBeaver wrote:
Thu Sep 20, 2018 4:18 pm
One more thing to check: while the child tax credit has been increased, not all of it is refundable. As a result, maximizing the saver's credit with children could result in no actual benefit, since your total credits might exceed your tax liability.
Good point. The saver's credit is non-refundable. How much of the child tax credit is refundable?
The 2018 forms are not finalized yet. Here is the draft:
https://www.irs.gov/pub/irs-dft/f1040s8--dft.pdf
https://www.irs.gov/pub/irs-dft/i1040s8--dft.pdf

Looks like $600 is non-refundable, while up to $1400 is refundable, limited to a maximum of 15% of earned income above $2500.

channtheman wrote:
Fri Sep 21, 2018 1:54 pm
banhbao wrote:
Thu Sep 20, 2018 7:56 pm
You didn't state how long you have until retirement, which I believe is an important consideration.

Because with the Roth (as long as you follow the rules), you won't pay taxes at all on the interest/dividends/capital gains. So if you invest wisely and earn a lot of compound interest over the years, your initial investment could be multiplied a few times over and you'd get all that tax-free.

But with the traditional IRA, you'll have to pay taxes on the interest.

If you're young I'd rather pay taxes on $5,500 now rather than $20,000 later.
I'm 27 and have a long ways to go until retirement. In doing some calculations last night with my wife, I was leaning towards a couple thousand in the traditional to lower my AGI to ensure saver's credit eligibility, and then putting the rest into the roth.
Given that information, I'd highly suggest just going Roth, unless you don't think your income will rise in the future. If needed, you can then also contribute to a traditional IRA prior to filing your tax return to limit your AGI to the top of the 10% Saver's Credit eligibility value (63k for 2018).

I did this for many years in a Roth IRA while having lower income before going back to school for a 'real' career, and it has served me well. Most projections now show that I will have roughly 50/50 traditional/Roth account balance mix at retirement, while putting the vast majority of earnings from the 12/15% bracket into Roth, and the vast majority of 22/24% bracket income into traditional.

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FiveK
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Re: Roth 401k or Traditional?

Post by FiveK » Fri Sep 21, 2018 5:31 pm

MrBeaver wrote:
Fri Sep 21, 2018 3:28 pm
The 2018 forms are not finalized yet. Here is the draft:
https://www.irs.gov/pub/irs-dft/f1040s8--dft.pdf
https://www.irs.gov/pub/irs-dft/i1040s8--dft.pdf
Thanks! Hadn't seen those for the "additional child tax credit" yet. Can you reach further into your bag of tricks and produce the draft forms for the "child tax credit"?

It hasn't been clear whether the tax consumes the refundable part first or the non-refundable part.

MrBeaver
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Re: Roth 401k or Traditional?

Post by MrBeaver » Fri Sep 21, 2018 11:50 pm

FiveK wrote:
Fri Sep 21, 2018 5:31 pm
MrBeaver wrote:
Fri Sep 21, 2018 3:28 pm
The 2018 forms are not finalized yet. Here is the draft:
https://www.irs.gov/pub/irs-dft/f1040s8--dft.pdf
https://www.irs.gov/pub/irs-dft/i1040s8--dft.pdf
Thanks! Hadn't seen those for the "additional child tax credit" yet. Can you reach further into your bag of tricks and produce the draft forms for the "child tax credit"?

It hasn't been clear whether the tax consumes the refundable part first or the non-refundable part.
To know for sure, we’ll need 2018 instructions for 1040 and pub 972.

If I had to guess, I’d say that line 3 of s8812 will represent the potential tax credit if t were non-refundable ($2000 * number of dependents minus tax liability) prior to computing the refundable portion of the credit. Thus, the tax would consume the non-refundable portion first, and the refundable portion would be considered only if total tax liability was less than the total non-refundable credit ($2000 per child). But that is all speculation until we see pub 972 or i1040.

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grabiner
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Re: Roth 401k or Traditional?

Post by grabiner » Sun Sep 23, 2018 11:33 am

MrBeaver wrote:
Fri Sep 21, 2018 3:28 pm
FiveK wrote:
Fri Sep 21, 2018 12:37 am
billfromct wrote:
Fri Sep 21, 2018 12:06 am
...can you verify (IRS wise) that the Saver's Credit is calculated on a maximum of $2,000 (single) or $4,000 (married filing jointly) contribution figure?
Yes, that is correct. See line 6 of Form 8880.
Yep. For this reason, the middle zone of the saver's credit is basically worthless. At 38k AGI (MFJ), the benefit can be $2000. At 41k AGI (top of the 20% zone) the benefit is reduced to $800. Essentially, if you are saving $4000 for retirement as a married couple and your ending tax liability is more than $0, your marginal tax rate from 38k to 41k of AGI is 38.6%.
The benefit is not $2000, because the saver's credit is nonrefundable; it is essentially impossible to get the full benefit. A married couple with $38K AGI taking the standard deduction with no non-refundable credits owes $1400 in tax, which is reduced to zero by the saver's credit. At $41K, the tax is $1700, reduced to $900 by the saver's credit. If you have one child, the tax at $41K is still zero because of the child tax credit, and there is no cost to the extra income. If you have two or more children, the marginal tax rate increases again, but because of the phase-out of the earned income credit rather than the saver's credit.
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FiveK
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Re: Roth 401k or Traditional?

Post by FiveK » Sun Sep 23, 2018 2:29 pm

grabiner wrote:
Sun Sep 23, 2018 11:33 am
...the saver's credit is nonrefundable; it is essentially impossible to get the full benefit.
Uncommon, but possible without too much contortion.

Easiest example is HOH with one CTC-eligible dependent making $30,500. Tax = $1050, saver's credit = $1000 (max for one person), non-refundable CTC = $50, EIC = $1569, and refundable CTC = (either $1400 or $1350, depending on pub. 572 details noted in a previous post).

It may be correct that no "straightforward" MFJ or S filing situation can get the full saver's credit. With excess Advance Premium Tax Credit (APTC) tax, it does become possible:
- MFJ making $42K, each making a $2K tIRA contribution, and owing $1550 in excess Advance Premium Tax Credit tax ($2K/mo premium, $2K/mo APTC, SLCSP = $24K) owes $1400 "normal" tax + $1550 excess APTC tax and gets the $2000 saver's credit, owing $950 net.

- S making $21K, making a $2K tIRA contribution, and owing $300 in excess Advance Premium Tax Credit tax ($1K/mo premium, $1K/mo APTC, SLCSP = $12K) owes $700 "normal" tax + $300 excess APTC tax and gets the $1000 saver's credit, hitting net $0 on the nose.

Add 1 CTC-eligible dependent to the MFJ example and the excess APTC tax drops to $600, making the saver's credit of $2000 exactly equal to $1400+$600. An EIC of $641 and a $1400 refundable CTC gives $2041 due from the IRS.

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