I want to remind you about the retirement tax credit for lower/middle-income working families. Assuming you meet the eligibility requirements, you can claim a tax credit for your retirement plan contributions for 2012. Eligible retirement plans include 401(k)s, 403(b)s, a 457 plan (for government employees), traditional IRAs, and Roth IRAs, among others.
Let’s talk briefly about the Roth IRA, because it can represent your chance to “double-dip” the tax code—legally. When you make contributions to a Roth IRA, they are made with after-tax money. So you don’t get any tax break for them up front (normally). Instead, if you handle a Roth IRA properly, you can take tax-free withdrawals when you’re retired. Not just tax-deferred withdrawals, but tax-free—no matter how much you take out in retirement.
So this year, if you make Roth IRA contributions and you can claim the retirement savers credit mentioned above, you will get a tax break now. Then later when you retire, you’ll get another big tax break when you take money out of the Roth IRA in the future—no income tax due at all. Getting two tax breaks on one transaction very rarely occurs. This is Congress’ way of encouraging you to put away a little money for retirement. And this strategy can really pay off this year if income tax rates rise in the future, as many pundits predict.
If you don’t currently participate in your employer’s retirement plan (assuming you have one), give some serious thought instead to making a Roth IRA contribution for this year. If you have to take some money out of savings to make the Roth contribution, that may not be a bad idea. Why? Any money you contribute to a Roth can be taken back out at any time without tax or penalty.
The earnings in the Roth are a different story—don’t touch those (or you will face taxes and penalties). But any money you deposit (your principal) can be taken back out whenever you like. (To claim the retirement savers credit mentioned above, you’ll need to leave the money in the Roth account until after April 15th, at least. Get your tax advisor to explain all the rules, so you clearly understand how this all works. There are income limitations based on your adjusted gross income and filing status, for instance.)
Just make sure that if you do using savings to fund your Roth IRA, you invest the Roth IRA in something very safe (like a money market account). That way if you do have an emergency and need to take any principal out, your money will be there. If not, then you just have an extra leg up on maximizing your retirement readiness in the future!