Author Topic: Child tax credit, marginal tax rate, and roth decision  (Read 3155 times)

unflinching

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Child tax credit, marginal tax rate, and roth decision
« on: January 21, 2014, 10:19:26 AM »
Trying to figure this one out but I'm not so hot with basic math.

The child tax credit takes $1k off of your tax bill, so for purposes of determining which tax treatment to give my savings (deferred or after tax), how much "free money" does this give me? If I'm in the 15% bracket does it mean I can squirrel away $6,666 in a roth basically tax free? (.15/1000)

I.E. 2014 Married Joint, no tax credit
Taxable income of 24,816
Taxable income up to 18,150 is at 10%, meaning you owe $1,815
6,666 at 15% means you owe $1,000
Final bill $2,815

With the child tax credit
Taxable income of 24,816
18150 at 10% means you owe $1,815
6,666 at 15% means you owe $1,000
Minus tax credit of $1,000
Final bill still $1,815

bevathome

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Re: Child tax credit, marginal tax rate, and roth decision
« Reply #1 on: January 21, 2014, 10:49:51 AM »
I cannot answer the tax question without further research, but the Roth IRA limit for 2014 is $5,500 for people under 50, and $6,500 for people age 50 and older.  And Roth IRAs contributions are from after-tax money.

seattlecyclone

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Re: Child tax credit, marginal tax rate, and roth decision
« Reply #2 on: January 21, 2014, 11:58:55 AM »
I'm not sure I understand your question. The child tax credit gives you $1,000 independent of whether you contribute to an IRA or not. When considering the difference between a Roth and traditional IRA, this is a more relevant comparison:

$5,500 traditional IRA contribution
Taxable income of $19,316 (the IRA contribution is deductible so your taxable income goes down by $5,500)
Taxable income up to $18,150 is at 10%, meaning you owe $1,815
$1,166 at 15% means you owe $175
Tax before credits is $1,990
Child tax credit is $1,000
Final bill $990

$5,500 Roth IRA contribution
Taxable income of $24,816 (the IRA contribution is not tax deductible)
Taxable income up to $18,150 is at 10%, meaning you owe $1,815
$6,666 at 15% means you owe $1,000
Tax before credits is $2,815
Child tax credit is $1,000
Final bill $1,815

So if you're in the 15% tax bracket, maxing out your Roth will mean you pay $825 more tax this year than maxing out a traditional IRA. The money in the Roth will grow tax-free indefinitely, so you may decide an extra $825 this year is worth tax-free gains for a few decades.

If your taxable income really is $24,816 and you have a child, I would recommend you look into the retirement savings contribution credit (also known as the "saver's credit") and the earned income tax credit. These are likely to reduce your tax burden even further, and might even cause the government to give you money.

Christiana

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Re: Child tax credit, marginal tax rate, and roth decision
« Reply #3 on: January 21, 2014, 03:48:39 PM »
Remember that you can take a dependent exemption for the child, which would lower your taxable income by another $3900, in addition to the $1000 child tax credit and the Earned Income Tax Credit.

MustachianAccountant

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Re: Child tax credit, marginal tax rate, and roth decision
« Reply #4 on: January 22, 2014, 11:12:17 AM »
Also, if your income is indeed 24k, and you file MFJ, then the Retirement Savings Credit is going to kick in as well when you contribute to your IRA.

Mazzinator

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Cheddar Stacker

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Re: Child tax credit, marginal tax rate, and roth decision
« Reply #6 on: January 22, 2014, 04:19:59 PM »
I had to read your post 3-4 times to fully understand what you were asking, but I think I got it now.

You never mentioned whether this was IRA or 401K, so I'm going to assume it's 401K with a limit of $17,500. If it was an IRA you are ignoring the rules (i.e.-the $5,500/$6,500 annual IRA limit). The simple answer to your question is yes, sort of.

Let me re-phrase the question based on my understanding of it: If I have 0 kids today, but theoretically (or actually) have 1 kid at the end of 2014, will this child tax credit plus a contribution to a ROTH allow me to pay the same amount of tax as if I had 0 kids and an equal contribution to a TRADITIONAL? If that is your question, and again ignoring the IRA limits, the answer to your question is yes. Here's an actual example of how it would play out based on 401K rules:

                                                    0 Kids              1 Kid
                                                    Traditional         Roth
                                                     401K               401K
         
Taxable Income in your Example    $24,816        $24,816
Additional Exemption                            -              (3,950)
Add Roth Contribution                           -              10,616
Taxable Income                                24,816        31,482
Tax                                                  2,815          3,815
Child Tax Credit                                       -         (1,000)
Total Tax                                         2,815          2,815

I added the Roth contribution because if you're taking traditional contributions and turning them into Roth, this will increase your taxable income. I increased your $6,666 contribution to $10,616 because of the $3,950 exemption as Christiana pointed out. So, if you are currently contributing to a traditional 401K, and you want to change to a Roth because you are having a kid and you want to keep your tax bill the same, you have up to $10,616 in "tax-free Roth contributions" as you stated in the original post.

I did not factor in the savers credit, or EIC, or anything else as it gets too convoluted. You also specifically stated taxable income, so I used that as my baseline for the scenario. If you meant gross W-2 income, net W-2 income, AGI, or something else these numbers aren't good. I hope that helps. If not, let me know and I'll re-run with your actual intentions/numbers.