IRA income limits

Overview

ROTH IRA and traditional IRA account contributions are subject to income phaseout limits.  In the case of the ROTH IRA the limits are related to eligibility and in the case of a traditional IRA the limits are related to deducting the contributions.  If you exceed these limits you may want to consider alternatives for deferring taxes on your retirement savings.  There are many options available depending upon your particular situation.  In general, business owners and self employed individuals have more options available to them than do W-2 employees.  The details of the income and phaseout limits are discussed in detail below.

ROTH IRA income limits

You are typically able to make a ROTH IRA contribution if your income falls below certain levels.  If you are married filing jointly, you can make a full ROTH IRA contribution if your adjusted gross income (AGI) is less than $186,000 for the 2017 tax year.  You can make a reduced contribution if your AGI is between $186,000 and $196,000, and contributions are disallowed altogether if your AGI is greater than or equal to $196,000.

If your tax filing status is single or head of household you may make a full ROTH IRA contribution for the 2017 tax year if your AGI is less than $118,000,  a reduced contribution if your AGI is between $118,000 and $133,000, and no contribution at all if your AGI is greater than or equal to $133,000.

If you are not able to make a ROTH IRA contribution due to income restrictions, you may want to investigate whether or not your employer offers a ROTH 401K plan.  If they do not, you should consider making a request to your employer that a ROTH 401K plan be implemented.

ROTH IRA income limits for 2017 tax year
filing status income limit
Married filing jointly full contribution allowed for AGI less than $186,000; phaseout for AGI between $186,000 and $196,000, no contribution allowed for AGI greater than or equal to $196,000
Single full contribution allowed for AGI less than $118,000; phaseout for AGI between $118,000 and $133,000, no contribution for AGI greater than or equal to $133,000
Head of household full contribution allowed for AGI less than $118,000; phaseout for AGI between $118,000 and $133,000, no contribution for AGI greater than or equal to $133,000
Married filing jointly (and lived with spouse at any time during year) phaseout for AGI between $0 and $10,000, no contribution for AGI greater than or equal to $10,000

Traditional IRA income limits

There are no income restrictions related to making a contribution to a traditional IRA, however you may not be able to deduct the contributions if you or your spouse participates in a retirement plan at work.  If you or your spouse participate in a retirement plan at work, the deduction begins to phaseout at $62,000 AGI for single or head of household ($99,000 for married filing jointly) and phases out completely at $72,000 AGI ($119,000 for married filing jointly).  These numbers are for the 2017 tax year.  If you are in this situation, you should consider contributing to your retirement plan at work, such as a 401K plan, as you will be able to deduct these contributions up to their limit.

Traditional IRA income limits for 2017 tax year
filing status no retirement plan at work retirement plan at work spouse has retirement plan at work (and you do not)
Married filing jointly no limits full deduction up to contribution limit if AGI less than $99,000, partial deduction for AGI between $99,000 and $119,000, no deduction if AGI is greater than $119,000 full deduction if AGI less than $186,000, phaseout for AGI between $186,000 and $196,000, no deduction if AGI is greater than $196,000
Single no limits full deduction up to contribution limit if AGI less than $62,000, partial deduction for AGI between $62,000 and $72,000, no deduction if AGI is greater than $72,000 N/A
Head of household no limits full deduction up to contribution limit if AGI less than $62,000, partial deduction for AGI between $62,000 and $72,000, no deduction if AGI is greater than $72,000 N/A
Married filing separately no limits partial deduction for AGI between $0 and $10,000, no deduction if AGI is greater than or equal to $10,000 partial deduction for AGI between $0 and $10,000, no deduction if AGI is greater than or equal to $10,000

ROTH 401K and ROTH IRA income limits

ROTH 401K and ROTH IRA accounts provide retirement savings options which are fully tax free upon withdrawal as long as they comply with certain IRS rules.  A disadvantage of ROTH IRA accounts is that they are restricted to lower income earners.  In order to contribute to a ROTH IRA for the 2017 tax year, your adjusted gross income must be less than $196,000 if you are married filing jointly and less than $133,000 if you are filing as single or head of household, and the amount of the allowable contribution phases out as it approaches these limits.

A ROTH 401K plan, unlike a ROTH IRA, has no income limits for the participant.  Regardless of income, for the 2016 tax year an individual may contribute up $18,000 to a 401K account (ROTH or traditional).  This limit increases to $24,000 for participants age 50 or older.  Unlike a traditional 401K plan, contributions made to a ROTH 401K are made on an after tax basis.  Keep in mind that employer contributions to a 401K plan, unlike ROTH 401K employee contributions, are always taxable to the plan participant upon their withdrawal.

Whether or not a high income earner should contribute to a ROTH 401K plan depends on a variety of factors.  On one side of the argument, a high income earner is in a high tax bracket and may be better off contributing to a traditional 401K as the immediate tax benefit could be significant.  On the other hand, ROTH 401K accounts have numerous advantages related to tax free withdrawals as well as limited rules related to required minimum distributions.  A careful analysis should be done of your financial situation, with particular attention paid to your tax bracket now and your expected tax bracket in retirement.

 

ROTH IRA or traditional IRA? A comparison

Overview

Individual retirement accounts (“IRAs”)  provide an excellent option for funding your retirement due to their numerous tax advantages.  They are typically administered by a financial institution such as a bank, broker/dealer, trust company or insurance company, which acts as the trustee for the account.  There are many types of IRAs, including SEP IRAs, SIMPLE IRAs, rollover IRAs, traditional IRAs, and ROTH IRAs.  The two most common types of IRAs are ROTH IRAs and traditional IRAs, which I will review in detail here.  Each of these retirement savings vehicles has its advantages and disadvantages from a tax perspective.  Which one is more advantageous for your particular situation will depend on a variety of factors, including your age, time horizon, income (and tax bracket), investment objectives, and expected income and tax bracket in retirement.   In most cases I believe that a ROTH IRA provides a greater benefit overall however I will review in detail the advantages and disadvantages of both of these retirement savings vehicles in this article.

ROTH IRA versus traditional IRA
ROTH IRA Traditional IRA
Contributions not deductible deductible*
Withdrawals not taxable taxable
Withdrawal penalty (prior to age 59 1/2) on earnings only on total distribution
Eligibility subject to income limits  no income limits*
2016 contribution limit $5,500 per year ($6,500 if age 50 or over) $5,500 per year ($6,500 if age 50 or over)
Required minimum distribution no yes

*deduction subject to phaseout limits if you have a retirement plan at work

IRA Contributions

For both the traditional IRA and ROTH IRA an individual may contribute up to $5,500 if under the age of 50, and up to $6,500 if age 50 or over per tax year, for 2016 and 2017.  However, an individual may not contribute more than their employment income.  ROTH IRA contributions are also subject to income limits.  While traditional IRAs do not have income limits, you may not be able to deduct contributions if you or your spouse have a retirement plan, such as a 401K or 403B plan, at work.

 

Traditional IRA – take a tax deduction now, pay taxes later

As long as you are not subjected to certain income phaseout limits, IRA contributions are tax deductible in the year in which they are made.  You will, however, have to pay ordinary income taxes on the withdrawals.  You will also be subjected to a penalty tax if you make withdrawals prior to age 59 1/2 (unless you qualify for certain exceptions).  Money invested in a traditional IRA grows tax deferred, so you will not have to pay taxes related to the growth or income in the account until you start taking withdrawals from the IRA.  You can make contributions to a traditional IRA up until age 70 1/2, after which point you will need to take a required minimum distribution each year (this is true for SEP and SIMPLE IRAs as well).  The amount of the required minimum distribution which you must take increases each year based upon your age according to mortality tables which are part of the IRS code.  The required minimum distribution rule makes it difficult for the account holder to continue to grow the account after age 70 1/2 as funds must be withdrawn from the account every year, thus subjecting these funds to income taxes.

Even if you do not qualify to take a deduction for your traditional IRA contribution, you can still benefit from its tax deferral feature.  However, you may be better off making a contribution to a 401K plan instead, as you will be able to deduct your contributions there up to the limit.

ROTH IRA – no tax deduction now, withdraw tax free later

ROTH IRA contributions are not deductible in the year in which they are made.  However, ROTH IRA withdrawals are not taxed as long as the ROTH IRA has been in existence for at least five years and are taken after age 59 1/2 (if either of these criteria are not met, the earnings on the ROTH IRA are subject to a 10% penalty tax).  ROTH IRA contributions can be made at any age, and there are no required minimum distributions as there are with a traditional IRA.  These features make the ROTH IRA a very attractive choice for retirement because the account holder is able to keep the funds in the account for extended period of time, where they can continue to grow and compound tax free.  The account holder has the option to withdraw portions of the ROTH IRA assets to fund retirement, and is able to do so tax free, but is not required to.

ROTH IRA conversion and recharacterization

Oftentimes it is advantageous from a tax planning standpoint to change an existing traditional IRA account to a Roth IRA account.  This is known as a Roth IRA conversion. Roth IRA accounts and traditional IRA accounts have different advantages and benefits.  As discussed previously, traditional IRA accounts provide an immediate tax benefit while Roth IRA accounts provide a tax benefit at the time of withdrawal.

A Roth IRA conversion would subject the IRA account owner to income taxes on the withdrawal from the traditional IRA account in the year that the conversion is made.  As Roth IRA withdrawals are tax free, the account owner will not have to pay any additional taxes on Roth IRA withdrawals once the taxes on the Roth IRA conversion have been paid.  A Roth IRA conversion should only be executed after careful analysis and tax planning has been done, with particular attention paid to income tax brackets in the current year as well as projected income tax brackets in future years.

In some other situations it becomes necessary to change IRA contributions which have already been made.  This would occur when the account owner wishes to change  traditional IRA contributions to Roth IRA contributions in order to take advantage of the benefits of the Roth IRA, or vice versa.  A common example of a recharacterization is when an individual subsequently becomes ineligible for a Roth IRA due to exceeding the relevant income limits, after the Roth IRA contributions have been made.  In this case, the account owner can recharacterize those contributions, and typically has until the tax filing deadline, including extensions, to do so.