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(March 11th, 2008) Making Roth IRA contributions has gotten ever more complex with increased rules & regulations that control your contribution limits, eligibility, modified adjusted gross income, etc. In this article, we will explore Roth IRA contributions in greater detail and compare them with making contributions to other IRAs. A Roth IRA investor can make an annual non tax-deductible contribution to a Roth IRA that may not exceed i) the maximum Roth IRA contribution limit set by the IRS or ii) 100% of the individual's earned income for the year minus iii) the sum of all contributions to all other individual retirement plans for that year (other than an Education IRA). Do you see how a simple Roth IRA concept can get so complicated? Let's explain these clauses. This means that the total contributions you make towards both a traditional IRA and a Roth IRA cannot exceed the defined contribution limit for that year. It is therefore better to pick only 1 out of the two options; traditional IRA or Roth IRA and make the total allowable contribution to it. For example if John has $5000 to contribute towards his IRAs, he would be better off putting all the $5000 to a Roth IRA, as opposed to contributiong $1500 to a traditional IRA and $3500 to a Roth IRA. This eliminates the administrative costs of maintaining & signing up for two different retirement programs, as well as broker fees, etc. Here are 2 important notes to remember about Roth IRA contributions: i) You can contribute to a Roth IRA and a Simple/SEP/Education IRA at the same time. The annual contribution limit to IRAs is applicable only to traditional & Roth IRAs; not the Simple/SEP/Education IRAs. Therefore if you have the money to make 100% of allowable contributions to a Roth IRA as well as a Simple or SEP or Education IRA, then by all means you can do so! ii) You can contribute to a Roth IRA even if you are already enrolled in a company sponsored 401k/profit sharing plan. Example Consider Mohammed who is a programmer and earns $60,000 a year. Mohammed contributes to his employer sponsored 401k plan as well as the company's pension plan. In his spare time, Mohammed runs an auto detailing shop from his basement that nets him an extra $10,000 a year. Mohammed will therefore make an SEP IRA contribution based on his net business income. Mohammed also contributes to an Education IRA for the benefit of his son, Ahmed. The beauty of Roth IRAs is that despite of all these contributions to a 401k, SEP IRA and an Education IRA, Mohammed can contribute a further $5000 to a Roth IRA for the year 2008. This is because $5000 is the total allowable contribution that can be made to a Roth IRA in 2008. Note: A qualified rollover contribution to a Roth IRA does not count in the maximum annual contribution limit. In the example above, Mohammed could make a qualified rollover contribution from his SEP IRA to his Roth IRA and that amount would not count as part of the $5000 contribution limit; meaning MOhammed could contribute an additional $5000 on top of his qualified rollover contribution. Beauty! Eligibility for Roth IRA Contributions Some individuals may not be eligible to make Roth IRA contributions based on tax filing status and modified adjusted gross income (MAGI). Here's the deal. Single & Head of Household In order to file under the Single & Head of Household category, an individual must be making LESS than $95,000 a year in order to be eligible to contribute $5000 to a Roth IRA in 2008. If the MAGI exceeds $110,000, that individual is totally barred from making Roth IRA contributions. For individuals making between $95,000 - $110,000, only partial contributions are permitted based on phase out ranges. Joint Filing (with Spouse) In order for a couple to file under the Joint Filing case, their modified adjusted gross income (MAGI) must not exceed $150,000. Between incomes of $150,000 - $160,000, their contribution ability is reduced with phase-out ranges. For a MAGI of $160,000 or more, no Roth IRA contributions will be allowed. Married Filing Separately For married/separate filers, the phase-out range is $10,000 making it almost impossible to contribute to a Roth IRA. When adjusted gross income exceeds $10,000, no Roth IRA contributions are allowed at all! Phase Out Ranges - Example Melina, a Single has an adjusted gross income of $105,000. Since the phase-out range for Singles is between $95,000 - $110,000, Melina is in Phase 2 (in increments of $5000 starting from $95,000). Since she is in Phase 2, she is allowed only 1/3rd of the maximum Roth IRA contribution limit for that year, $5000 for 2008. Therefore, Melina can contribute $5000 x 1/3 = $1667. Since her Roth IRA was limited, can she contribute the remainder $5000 - $1667 = $3333 to a traditional IRA? Yes she definitely can! Will that contribution be tax-deductible? Yes it will be in her case because she is not participating in an employer sponsored IRA or 401k plan. If she was, her deductibility would be limited.
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