This year, if you (as a single tax filer) earn more than $99,000 (modified adjusted gross income—MAGI), your eligibility for the tax-advantageous Roth IRA phases out until you don’t qualify at all at $114,000. Couples are at a little bit of a disadvantage compared to two single tax filers as eligibility starts to phase out at $156,000 and is eliminated completely with a combined income of $166,000.
My modified adjusted gross income won’t reach $99,000 this year thanks to my 401(k) contributions that I can take right off the top. But this may be a concern in the future. I have scheduled automatic investments twice each month to maximize my Roth IRA contribution—currently at TIAA-Cref—at a total of $4,000. If my income grows in the second half of the year, I might have to make changes to this plan.
Here are the details of the phase-out. Prior to this research, I knew that someone my age can contribute the full $4,000 to a Roth IRA with an MAGI of under $99,000 and can contribute none with an MAGI of over $114,000. But if the MAGI sits somewhere in between the two amounts, here is the fairly simple calculation.
Contribution Limit = Maximum Contribution × (Upper Limit of Range − Modified Adjusted Gross Income) ÷ (Upper Limit − Lower Limit of Range)
For example, if my MAGI for 2007 is $104,000, here is the calculation:
Contribution Limit = $4,000 × ($114,000 − $104,000) ÷ ($114,000 − $99,000)Contribution Limit = $4,000 × $10,000 ÷ $15,000
Contribution Limit = $2,667
Assuming that the laws and regulations don’t change, the difference between the $2,667 calculated limit and the $4,000 original limit can be invested in a Traditional IRA and converted to a Roth in 2010. Tax on the deferred income in the Traditional IRA will be due at that time.
Are these phase-outs fair? It makes sense to invest in a Roth IRA when your tax rate now is lower than your expected tax rate at retirement. With that in mind, Roth IRAs are good for those in a low tax bracket and not making a lot of money. Making this decision depends on one massive assumption: tax rates will remain consistent between now and your retirement. The farther from retirement you are, the bigger the assumption.
I don’t think the phase-out is that much of a big deal. There are many options for saving for retirement, and the Roth IRA encourages the vast majority of Americans who are earning even above average income to invest and think about the future.
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Hmmm, I wonder if it makes sense to file separately if you are near that limit and are married.
Married, filing separately isn’t quite like filing single. The phase-out range is from $0 to $10,000 MAGI, so there’s hardly any Roth IRA allowed at all.
If you are married, filing separately and living apart, then the phase-out range is the same as filing single.
It’s pretty easy to get around the phaseout given that they’re lifting the income cap requirment on a conversion. Just put the money into a non-deductile IRA and covert it after 2010. I think the flexibility of the Roth makes it too attractive do anything but maximize your dollars in it.
We were forced to withdraw almost all 2006 contributions this April because of the phase out limit. As Dong said, right now the easiest way to deal with it is get a non-deductible IRA account and move the excess contribution to the that account and wait till 2010 to convert it back to Roth once the limit is removed.