The definition of modified adjusted gross income depends on the tax break you're trying to qualify for. For example, the MAGI formula for contributing to a Roth IRA is different from the formula for claiming the American opportunity credit, which is also different from the formula for figuring whether Social Security benefits are taxable.
Sometimes the tax code functions to limit who can claim a certain deduction or credit. For example, when figuring your MAGI to determine whether you can contribute to a Roth IRA, any income from a Roth IRA conversion that year isn't counted in your MAGI. By contrast, your MAGI does count Roth IRA conversion income when figuring whether you can deduct your traditional IRA if you participate in a 401(k) or other employer plan. However, all MAGI formulas for IRA contributions, education tax benefits and determining whether your Social Security benefits are taxable include taxable IRA distributions, but not nontaxable withdrawals.
Traditional IRA Cash-Outs
When you cash out your traditional IRA, it's almost always going to increase your MAGI even if you're taking a qualified distribution. Unless you've put in nondeductible contributions -- traditional IRA contributions that you didn't take a deduction for -- any money you withdraw counts as taxable income. Even if you made nondeductible contributions, only a portion of your traditional IRA distribution comes out tax-free. For example, say you're cashing out $20,000 and your traditional IRA contains 33 percent nondeductible contributions: $6,600 of your distribution is tax-free, so your MAGI only goes up by $13,400.
Qualified Roth Withdrawals
Qualified Roth IRA distributions come out tax-free no matter how much you're cashing out, which doesn't affect your MAGI. But, qualifying can be tricky. First, five years have to pass from January 1 of the first tax year you contributed and when you're cashing out. So, if you made your first contribution at any time during the 2013 tax year, you have to wait until January 1, 2018, to satisfy the first requirement. Second, at the time you cash out the money, you must be either 59 1/2, permanently disabled, or cashing out $10,000 or less for a first home purchase.
Early Roth Cash-Outs
Early Roth IRA cashouts, on the other hand, might increase your MAGI. The IRS rules let you take out all your contributions first and they come out tax-free. So, if you're cashing out less than the contributions, you won't affect your MAGI. But, if you take out any earnings, those will increase your MAGI. For example, say your Roth IRA is worth $20,000 and contains $12,000 of contributions. If you cash out just $12,000, none of it counts as taxable income so your MAGI doesn't go up. But, if you take out $13,000, the last $1,000 is taxable and increases your MAGI.
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