An IRA is an individual retirement arrangement, more commonly called an individual retirement account. There are two main types of IRAs, the traditional IRA, and the Roth IRA, each of which has its advantages. Roth IRAs are popular because the distributions are not taxed if they are qualified distributions. (The contributions to a Roth IRA, however, unlike the contributions to a traditional IRA or an employer-provided qualified plan, are never deductible in the year that they are contributed.) In 2011 the income limit for contributing to a Roth IRA has been raised. (There is no income limit for a non-deductible contribution to a traditional IRA.)
Because the IRA gives an opportunity for sheltered income, all IRAs are regulated by Congress. The IRA is not meant to be a vehicle for the wealthy to avoid taxation, it is meant to allow all Americans the opportunity to save money for retirement. Because of the distinct tax advantages of Roth distributions, after you make a certain amount of money, the amount of money that you are allowed to contribute to a Roth begins to approach zero.
If, as a single taxpayer, you make up to $56,000 in 2011 then you are allowed to contribute $5,000.00 to a Roth IRA; if you are a married taxpayer, and you make up to $90,000 in 2011, then you can contribute $5,000.00 to a Roth IRA. If you are over 50, then you are allowed “catch-up” contributions of 1,000.00, bringing your contributions limit up to $6,000.00. After the income limits just explained, your contribution to a Roth IRA must be phased-down. This phase-out ends, and becomes 0.00 dollar contribution allowed, for married-filing joint taxpayers (or qualifying widowers) at 179,000. The phase-out ends for single, head of household or married filing separately (if you did not live with your spouse all year) at $122,000. What if you are filing married filing separately and you did live with your spouse at some time during the year? Then the modified adjusted gross income at which you can no longer contribute to a Roth IRA is $10,000, not a very big window.
Modified Adjusted Gross Income means something different for every tax law. Worksheet 2-1, Modified Adjusted Gross Income for Roth IRA Purposes, on page 59 of IRS Publication 590, “ Individual Retirement Arrangements,” will give detailed guidance on how to arrive at this figure. If you have income resulting from conversions of traditional IRAs or rollover from a 401-k to a Roth, then this adjustment will concern you. Also, if you have deductions resulting from traditional IRA contributions, student loan interest paid, tuition and fees, savings bond interest, domestic production activities, foreign income or housing exclusion, foreign housing deduction, or employer-provided adoption benefits, then this computation will affect you. If you have excessive deductions, or if you receive social security benefits, then there is additional instruction available here.
One of the tricks to sorting out the various complications of IRA qualifications is in the name of the arrangement, that is, “Individual” retirement arrangement. Each spouse in a marriage has separate accounts, and they are not contingent upon each other except in deciding limits dictated by income.
The IRA lower limits are decided by how much money you have made through compensation. “Compensation” isn’t as simple a concept as “earned income,” although it is similar. Compensation usually includes all amounts allowed in box 1 of the w-2 form, as well as commissions, self-employment income, taxable alimony and separate maintenance, and non-taxable combat pay. It doesn’t include what is usually considered “unearned income.” For a detailed discussion of what is and is not compensation for the purposes of an IRA, see page 8 of IRS Publication 590.
If you have $3,000.00 of compensation, and if no amounts are disqualified by the modified adjustments for the Roth IRA worksheet, then you may contribute all of it to a Roth IRA. If you have no “compensation,” then you are not allowed to participate in this form of retirement savings unless you file a joint return, and your spouse has adequate compensation, and your joint Modified Adjusted Gross Income for Roth IRA Purposes fits into the acceptable limits.
You can contribute to a spousal Roth IRA as long as you have remaining compensation after your own contribution (if any) has been made. If you file separately, however, these rules don’t apply. In that case, the separate spouses are limited to their own compensation.
If contributions are made to both traditional and Roth IRAs, the combined contributions must not be more than the allowable limits for contributions, but be aware that the differences in the IRA rules for traditional and Roth IRAs affect these limits after a certain income level is reached. Between 90,000 and 179,000 for a married filing joint income, for instance, the contributions for a Roth IRA are limited while the traditional IRA contributions are not limited by income level. (Although the amount that the traditional IRA participant can deduct may be affected by income level and employer participation.)
To figure any reduction in allowed contributions, (Whether you contribute to other types of IRAs or not) use the worksheet 2-2 on page 61 of IRS Publication 590, Individual Retirement Arrangements. Because of changes in the tax laws, these forms and worksheets are adjusted as needed on a year by year basis.
For the 2012 tax year, the income limits have been raised (except for married filing separately) but the contribution limits remain the same. In other words, you can make slightly more money ($2,000.00 per year) before your contribution begins to be limited, and the window is $2,000.00 larger before the contribution is phased out entirely.