Who Can Establish a Roth IRA?
Any individual who has taxable compensation or self-employment income (earned by sole proprietors and partners) for the year may establish and fund a Roth IRA. To be eligible to make a regular contribution, the individual must have a modified adjusted gross income (MAGI) that is less than a certain amount, depending on the tax-filing status of the individual. Here are the base MAGI limits for 2015 and 2016 tax years:
Roth IRA MAGI Limits 2015 and 2016 tax years
- $193,000 (2015), $194,000 (2016) for individuals who are married and file a joint tax return
- $10,000 (2015 & 2016) for individuals who are married, lived with their spouses at anytime during the year and file a separate tax return
- $131,000 (2015), $132,000 (2016) for individuals who file as single, head of household, or married filing separately and did not live with their spouses at any time during the year
Establishing a Roth IRA
A Roth IRA must be established with an institution that has received IRS approval to offer IRAs. These include banks, brokerage companies, federally insured credit unions and savings & loan associations.
A Roth IRA can be established at any time. However, contributions for a tax year must be made by the IRA owner’s tax-filing deadline, which is generally April 15 of the following year. Tax-filing extensions do not apply. (For background reading, check out An Introduction To Roth IRAs.)
There are two basic documents that must be provided to the IRA owner when an IRA is established:
These provide an explanation of the rules and regulations under which the Roth IRA must operate, and establish an agreement between the IRA owner and the IRA custodians/trustee.
For individuals working for an employer, compensation that is eligible to fund a Roth IRA includes wages, salaries, commissions, bonuses and other amounts paid to the individual for services the individual performs for an employer. At a high level, eligible compensation is any amount shown in Box 1 of the individual's Form W-2.
For a self-employed individual or a partner in a partnership, compensation is the individual’s net earnings from his or her business, less any deduction allowed for contributions made to retirement plans on the individual’s behalf, and further reduced by 50% of the individual’s self-employment taxes.
Other compensation eligible for the purposes of making a regular contribution to a Roth IRA includes taxable amounts received by the individual as a result of a divorce decree.
The following sources of income are not eligible compensation for the purposes of making contributions to a Roth IRA:
- rental income or other profits from property maintenance
- interest and dividends
- other amounts generally excluded from taxable income
Individuals whose MAGI falls within a certain range may not be able to contribute the full contribution limit. These individuals must use a formula to determine the maximum amount they may contribute to a Roth IRA.
Here is a chart outlining the ranges for each tax-filing category in 2016:
|Category||Income Range for 2016|
|Married and filing a joint tax return.||At least $184,000 but less than $194,000.|
|Married, filing a separate tax return and lived with spouse at any time during the year.||More than zero but less than $10,000|
|Single, head of household or married filing separately without living with spouse at any time during the year.||At least $117,000 but less than $132,000|
An individual who earns less than the ranges shown for his or her appropriate category can contribute up to 100% of his or her compensation or the contribution limit, whichever is less.
Those who fall within the ranges must use the following step-by-step formula to determine the amount they may contribute:
- Step 1 - Subtract the lowest dollar amount in the range from MAGI
- Step 2 - Divide the result in Step 1 by the difference between the lowest amount in the range and the highest amount in the range
- Step 3 - Multiply the result from Step 2 by the maximum contribution limit
- Step 4 - Subtract the result in Step 3 from the maximum contribution limit. The result is the amount the individual is allowed to contribute to a Roth IRA.
Let's illustrate how the formula works for three different individuals for the 2016 tax year:
- John, age 35, who is married, files a joint tax return and has a MAGI of $189,000
- Mary, age 30, who is married, files a separate tax return, lived with her spouse during the year and has a MAGI of $5,000
- Jane, age 52, who is single and has a MAGI of $124,000
|Range||$184,000 to $194,000||$0 to $10,000||$117,000 to $132,000|
|Step 1||189,000 – 184,000 = 5,000||5,000 – 0 = 5,000||124,000 – 117,000 = 7,000|
|Step 2||5,000 / (194,000 – 184,000)||5,000 / (0 – 10,000)||7,000 / (132,000 – 117,000)|
|5,000 / 10,000 = 0.5||5,000 / 10,000 = 0.5||7,000 / $15,000 = 0.467|
|Step 3||0.5 x 5,500 = 2,750||0.5 x 5,500 = 2,750||0.467 x 5,500 = 2,568|
|Step 4||5,500 – 2,750 = 2,750||5,500 – 2,750 = 2,750||5,500 – 2,568 = 2,932
Round up to the nearest $10 = $2,940
A Roth IRA can also be funded by a conversion.
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