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Since its introduction under the Taxpayer Relief Act of 1997, the Roth IRA - in which earnings accrue tax free - has become a popular retirement and estate-planning tool among U.S. taxpayers. According to a study done by the Investment Company Institute, Roth IRA assets increased to $178 billion as of December 200603. However, many individuals are prevented from participating in the Roth IRA because of the stringent qualification requirements. Here we revisit some of these requirements and explore some qualification opportunities that may be available to certain individuals.
Ways of Funding a Roth IRA
A Roth IRA may be funded through regular IRA contributions and assets converted from existing Traditional, SEP or SIMPLE IRAs. To make regular IRA contributions, an individual must have eligible compensation for the year and must meet the following requirements:
- If an individual's tax-filing status is 'single', his or her modified adjusted gross income (MAGI) must not exceed $116,000. An individual filing single may contribute up to $5,000 + catch-up for 2008 if his or her MAGI is less than $101,000. For individuals whose MAGI is between $101,000 and $116,000, the contribution limit is 'phased out'. This means a special formula must be used to determine the dollar amount that such individuals may contribute to the Roth IRA for the year. (The formula and step-by-step instructions are included in the chapter "Eligibility Requirements" in the tutorial Roth IRAs.)
- If an individual's tax-filing status is 'married filing jointly', the combined MAGI of both spouses should not exceed $169,000. Each spouse may contribute up to $5,000+ catch-up if their combined MAGI is not more than $159,000. If the couple's MAGI is between $159,000 and $169,000, the contribution limit is phased out.
- If an individual's tax-filing status is 'married filing separately', his or her MAGI must not exceed $10,000. If his or her MAGI is between $0 and $10,000, the contribution limit is phased out.
To fund a Roth IRA by means of Roth IRA conversions, an individual's MAGI must be $100,000 or less. This limit applies to individuals who file as single and those who file as married filing jointly. Individuals who file as married filing separately are not eligible for Roth IRA conversions.
| Tip: If you fall within the phase-out range, you may still find it in your best interests to seize the opportunity to fund the Roth IRA. In most cases, analysis shows that the benefit of funding the Roth IRA, at any allowable amount, outweighs the benefits of funding the Traditional IRA. |
RMD May No Longer Be Included in MAGI after 2004
Up to the end of 2004, many taxpayers of RMD age were ineligible to convert to a Roth IRA because their RMD amounts were added to their MAGI, causing their MAGI to exceed the $100,000 limit. This rule requiring the MAGI to include RMD amounts from Traditional, SEP and SIMPLE IRAs no longer applies to RMD for tax years beginning Jan 1, 2005.
| Tip: If you are unable to determine if your MAGI will exceed $100,000, you may wait until the next year to do your Roth conversion. On the other hand, you may convert the assets in the current year, and if it is determined that you are ineligible, the amount can be recharacterized to the Traditional IRA. |
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