Adoption Tax Credit: Retirement Savings Opportunity

If you have adopted a child recently, then you should know about the tax savings that you can take advantage of to help curb some of the cost to adopting.  But the Adoption Tax Credit offers families a unique opportunity to save for retirement.

The IRS has recently announced that the Adoption Tax Credit for 2012 is a non-refundable $12,650 per adopted child.  This means that if you have adopted a child in 2012, you are able to reduce your tax liability to zero, but won’t be able to get cash back like a refundable credit.  However, it is important to note that this tax credit can be rolled over for 5 years, giving you time to get the biggest bang for your buck.  If you want to know about the Adoption Tax Credit, check out this website.

But many middle-income earners still may not max out this credit within 5 years.  So here’s how to take full advantage of this credit.

A family, the Greens, is married with one child and they begin and finalize an adoption in 2012, costing the family $12,650 in expenses.  Because they want to save for retirement and reduce their current taxable income, they invest $5K each year in a traditional IRA.  If their taxable income is low enough, they might not be able to recoup all of their adoption expenses through the credit, even with the 5 year rollover allowance.  To get the most out of the credit, the Greens should consider options to reduce or defer their taxable income, and do the opposite.

Contribute to a Roth

One way to increase your current taxable income is to contribute to a Roth IRA instead of a traditional IRA.  Contributions to a Roth IRA are taxed at your current tax rate while contributions to a Traditional IRA are taxed at whatever tax rate you’ll pay in retirement.  The maximum contribution to a Roth IRA and a Traditional IRA in 2012 was $5000 per person per year, but has since increased to $5,500 for 2013.  

If the Greens find that they can rollover the Adoption Tax Credit for 5 years and take full advantage of it by contributing to a ROTH instead of a traditional IRA, they’ll have saved $12,650 in federal taxes.  However, the real value here is that they will have saved over $25,000 toward retirement totally tax free for each adult if they max out their Roth over the course of 5 years – no income tax now, tax-free capital gains within the Roth IRA, and tax-free withdrawals in retirement.

Rollover Your Traditional to a Roth

Another option available to the Greens is to rollover money they’ve already saved in their Traditional IRA into a Roth IRA.  Since they’ve already been putting money in to a Traditional IRA, they can simply rollover $25,000 into a Roth IRA.  (For more info on rolling over into a Roth, click here).  That $25,000 will be treated as income for the current tax year, but the Adoption Tax Credit will cover the large tax bill.  You get to take advantage of the benefits of a Roth IRA.

You’ve still got time

Though it’s 2013, you can still take advantage of this tax credit for 2012.  The IRS allows contributions for either type of IRA up to the day taxes are due to be credited to the previous year, April 15, 2013 for this year.  Remember to tell your financial institution that the contribution is for 2012.  If you want to rollover retirement funds to a Roth IRA, this transaction is taxable for the year in which the rollover is accomplished.




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