An individual retirement account (IRA) offers a powerful tax-preferred tool to invest money for retirement. It is important to understand the rules that govern contribution to an IRA to properly use this type of account. There are limits to how much one can contribute to an IRA and a maximum income defining who can contribute.
Types of IRAs
There are two types of IRAs that have been legislated by Congress and approved by the Internal Revenue Service. The traditional IRA is a tax shelter that allows income to be deposited to the account tax-free and taxed when the income is withdrawn. A Roth IRA allows post-tax earned income to be deposited to the account and then withdrawn tax-free.
MAGI and the Phased-Out Contribution
Two concepts that help illuminate the calculation to determine Roth IRA eligibility are modified adjusted gross income (MAGI) and the phased-out IRA contribution. A phased-out contribution means it is prorated between income limits. Closer to the lower limit, a Roth IRA saver can contribute a larger proportion, as this person earns more, closer to the upper limit, they can contribute less. Above the income limit, a person is no longer permitted to contribute to a Roth IRA. MAGI is calculated as total gross income less total IRS qualified deductions.
Minimum Income Considerations
While there is no minimum income limit for the Roth IRA, it is post-tax earned income that you deposit to your Roth account. If you have no earned income then you have no qualified money to deposit to your Roth IRA. If you have earned income, you could conceivably deposit all your earned income to your Roth IRA, up to the contribution limit. There is one exception to this rule: married couples. Married couples can each contribute to a Roth IRA; if one spouse has earned income and the other does not, they can make a combined maximum contribution. One caveat is if the married couple files separately and lived together at any time during the tax year, then the qualified contribution phase-out begins at $0 and the maximum MAGI is $10,000 before the individual is prohibited from saving in a Roth IRA.
For tax years 2009 and 2010, for all contributors the maximum annual contribution is $5,000 for everyone under 50 years old and $6,000 for all contributors who are 50 and older. For 2011 and beyond the maximum contribution will be adjusted based on the rate of inflation during the previous year. The official IRS inflation rate for 2010 has not yet been determined; therefore the annual contribution and maximum income limits have not been calculated for 2011.
There are several categories of taxpayers and depending on how one files, the maximum income limit for a Roth IRA contribution changes. For a married couple filing jointly, the maximum income to make a full Roth IRA contribution is less than $167,000. If the couple makes at least $167,000 and less than $177,000 the contribution limit is phased out as their income approaches the upper bound. If their income is above $177,000, they cannot contribute to a Roth IRA. For a single or head-of-household filer, the full Roth contribution limit is less than $105,000. Between $105,000 and less than $120,000, the contribution is phased out; and above $120,000 the taxpayer cannot contribute to a Roth IRA.
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