Some tax filers are eligible for a tax credit for contributing to an individual retirement account. In addition to the standard tax-deferred benefits of an IRA, a tax credit is received up front. The specific amount of the credit can sometimes be affected by whether the account is a traditional IRA or a Roth IRA.

The Credit for Qualified Retirement Savings Contributions is informally referred to simply as the saver's credit. The amount of the credit can be for as much as 50 percent of the eligible amount contributed to a traditional IRA or a Roth IRA.

Calculation of the credit

The saver's credit is calculated on IRS Form 8880. The credit can be for 10, 20, or 50 percent of the qualifying contribution amount. The applicable percentage is determined by the amount of taxable income reported on Form 1040. The amount of taxable income is lowered by the inclusion of a traditional IRA contribution. On the other hand, a Roth IRA contribution does not lower taxable income.

By funding a traditional IRA instead of a Roth IRA, you may be able to increase the credit percentage that applies to your contribution. The lower income reported on Form 1040 produces a higher level for the credit percentage. The amount of the credit calculated on Form 8880 is then carried back to Form 1040 and used to offset income tax.

Comparing the IRA options

You can open and contribute to an IRA up until the filing deadline for the affected tax year. This allows time after the end of the year to determine if your selection of account type will have an affect on your saver's credit percentage. For one person, the maximum contribution amount qualifying for the credit is $2,000. For a married couple, up to $4,000 in contributions can qualify for the credit.

Although the saver's credit is an enticing up-front benefit, there are some restrictions. The credit is only available to tax filers within specific income ranges. The credit is not refundable, which means that it can be used only to offset tax which would otherwise be payable.

For many individuals, the receipt of the saver's credit may be secondary to longer-term financial plans. Younger individuals might prefer to invest in a Roth IRA now in order to eventually receive the future earnings tax-free. For others, the saver's credit is likely to have some influence on their selection of IRA type.

For more information, contact Mary Anne Bohlinger  CPA LLC or a similar accounting professional.