To be eligible to contribute to a Roth IRA, you must have earned income from wages, salary, tips, bonuses, or self-employment income. Additionally, your modified adjusted gross income (MAGI) must fall within certain limits.
For the tax year 2022, if you are a single filer, your MAGI must be less than $142,000 to make a full contribution to a Roth IRA and less than $157,000 to make a partial contribution. If you are married and filing jointly, your MAGI must be less than $214,000 to make a full contribution and less than $224,000 to make a partial contribution.
It is also important to note that there is no age limit for contributing to a Roth IRA. However, if you are over age 70 ½, you are not eligible to make traditional IRA contributions.
Let's start by understanding important terms:
Gross Income is the total income you earn from all sources, including wages, salaries, tips, dividends, interest, and rental income.
Adjusted Gross Income (AGI) is your gross income minus certain deductions, such as contributions to a traditional IRA, student loan interest, and alimony paid. AGI is used to determine your eligibility for certain tax deductions, such as the deduction for medical expenses and the deduction for contributions to a traditional IRA.
Modified Adjusted Gross Income (MAGI) is calculated by adding back certain deductions to your AGI. The deductions that are added back depend on the specific tax benefits you are claiming. MAGI is used to determine your eligibility for certain tax benefits, such as the ability to contribute to a Roth IRA, claim certain tax credits, and the amount of your Social Security benefits that are subject to taxation.
How to calculate MAGI?
To calculate your MAGI, follow these steps:
Start with your Adjusted Gross Income (AGI), which you can find on line 11 of your Form 1040 tax return.
Add back any deductions that were taken out of your AGI that are not counted towards MAGI. These may include:
If you claimed any of the above deductions, you can find the amount to add back on Schedule 1, line 22 of your tax return.
If you claimed any of the following tax credits, add back the amount of the credit to your AGI:
If you received tax-exempt interest or excluded foreign-earned income, add it back to your AGI.
Once you have added back all applicable deductions and credits, you will have your MAGI.
Calculating MAGI can be complex, so it's a good idea to consult with a tax professional or use tax software to ensure accuracy.
What if your MAGI (Income) is too high for contributing to ROTH IRA?
If your MAGI is too high, you may not be eligible to make direct contributions to a Roth IRA. The contribution limit for a Roth IRA begins to phase out for single filers with a MAGI of $140,000 or more and for married couples filing jointly with a MAGI of $208,000 or more in 2022.
However, there are still options available to you to save for retirement.
You can make a nondeductible contribution to a traditional IRA and then convert it to a Roth IRA.
This is known as a "backdoor Roth IRA" contribution.
However, it's important to note that there are rules and restrictions associated with backdoor Roth IRA contributions, so it's best to consult with a tax professional before pursuing this option.
Here are a few important rules and restrictions to keep in mind if you're considering a backdoor Roth IRA contribution:
The contribution must be made to a traditional IRA first. You cannot contribute directly to a Roth IRA if your income exceeds the limits.
There are no income limits for contributing to a traditional IRA, but if you or your spouse are covered by a retirement plan at work, your ability to deduct your contribution may be limited based on your income.
You must wait at least one day after making your traditional IRA contribution to convert it to a Roth IRA.
When you convert your traditional IRA to a Roth IRA, you will owe taxes on any pre-tax contributions and earnings in the account.
If you have other traditional IRA accounts, the tax treatment of your backdoor Roth IRA conversion may be affected by the "pro rata rule." This means that the tax liability for the conversion will be based on the ratio of your nondeductible contributions to your total IRA balance.
It's important to report the backdoor Roth IRA conversion correctly on your tax return to avoid any potential penalties or mistakes.
If you have any other Roth IRA accounts, you may be subject to the annual contribution limit across all accounts.
Contribution Limits:
For 2022, the maximum contribution you can make to a Roth IRA is $6,000. If you are age 50 or older, you can make an additional catch-up contribution of $1,000, bringing your total contribution limit to $7,000.
For 2023, the maximum contribution you can make to a Roth IRA is $6,500. If you are age 50 or older, you can make an additional catch-up contribution of $1,000, bringing your total contribution limit to $7,500.
Why should you consider Roth IRA?
There are several benefits of a Roth IRA, including:
Tax-free withdrawals: Roth IRA contributions are made with after-tax dollars, so qualified withdrawals in retirement are completely tax-free. This can provide a significant tax advantage over traditional IRAs and 401(k)s, which are funded with pre-tax dollars and taxed at ordinary income tax rates upon withdrawal.
No required minimum distributions: Unlike traditional IRAs and 401(k)s, Roth IRAs do not have required minimum distributions (RMDs) during the lifetime of the account owner. This means you can keep the money in the account as long as you want, allowing it to grow tax-free for future generations.
Flexible contributions: You can make contributions to a Roth IRA at any age, as long as you have earned income. This can be especially beneficial for older workers who are continuing to earn income in retirement.
Withdrawal flexibility: Roth IRA contributions can be withdrawn at any time, tax and penalty-free. Additionally, you can withdraw earnings from a Roth IRA penalty-free for certain qualified expenses, such as a first-time home purchase or qualified education expenses.
Estate planning benefits: Because Roth IRA assets can be passed down to heirs tax-free, they can be a valuable tool for estate planning. This is because heirs who inherit a Roth IRA are not required to take RMDs, allowing the assets to continue growing tax-free for future generations.
Deadline for Roth IRA Contribution -
The deadline for making contributions to a Roth IRA is typically the tax filing deadline for the previous year, which is usually April 15th (or the next business day if April 15th falls on a weekend or holiday). For example, contributions for the 2022 tax year can be made until April 15th, 2023.
However, it's important to note that contributions must be made with earned income from the same tax year. In other words, you can't make contributions for the 2022 tax year in 2023 if you didn't have any earned income in 2022.
Additionally, if you file for an extension to file your taxes, the deadline for making contributions to a Roth IRA is also extended to the same date as the tax filing deadline.
Do it properly -
While it's not possible to completely avoid the possibility of an audit, there are some steps you can take to minimize your risk when converting a traditional IRA to a Roth IRA:
Accurately report the conversion: Make sure you report the conversion accurately on your tax return, including the amount converted and any taxes owed. If you're not sure how to properly report the conversion, consider consulting with a tax professional.
Keep detailed records: Keep detailed records of the conversion, including the amount converted, the date of the conversion, and any taxes paid. This can help you accurately report the conversion on your tax return and provide supporting documentation in case of an audit.
Consider a partial conversion: If you're concerned about the tax implications of a large conversion, consider doing a partial conversion over multiple years. This can help spread out the tax liability and potentially reduce your risk of an audit.
Be aware of contribution limits: Remember that contributions to a Roth IRA are subject to annual contribution limits. Make sure you're aware of these limits and don't exceed them, as this can trigger an audit.
Consult with a tax professional: If you're unsure about the tax implications of a Roth IRA conversion or want to minimize your risk of an audit, consider consulting with a tax professional. They can provide personalized advice and help you navigate the complex tax rules surrounding Roth IRA conversions.
