I've had a couple of comments from people saying I should be careful not to contribute too much to a Roth IRA. For 2007, I contributed the full $4,000, but that maximum only applies to people whose income was below $99,000. My total income in 2007 was just above $100,000-- so did I screw up?
Fortunately, the answer is NO! The income limit for Roth IRA contributions refers not to your gross income, but to your "Modified Adjusted Gross Income," abbreviated hereafter as MAGI. Maybe I should have called this post "The Gift of the MAGI..."
As I learned from the "Ask Encore" column in this past weekend's Wall Street Journal, you can figure out your MAGI by going to www.irs.gov and using a worksheet in Publication 590. They say it's on page 61, but I didn't see any page numbers-- I just found it by searching the table of contents for Roth IRA contribution limits.
The worksheet asks you to enter your adjusted gross income from line 38 on form 1040. Then you have to add back in a bunch of other lines, none of which applied to me. Below is the 2007 worksheet:
|1.||Enter your adjusted gross income from Form 1040, line 38; Form 1040A, line 22; or Form 1040NR, line 36||1.|
|2.||Enter any income resulting from the conversion of an IRA (other than a Roth IRA) to a Roth IRA or a minimum required distribution from an IRA (if figuring MAGI for conversion purposes)||2.|
|3.||Subtract line 2 from line 1||3.|
|4.||Enter any traditional IRA deduction from Form 1040, line 32; Form 1040A, line 17; or Form 1040NR, line 31||4.|
|5.||Enter any student loan interest deduction from Form 1040, line 33; Form 1040A, line 18; or Form 1040NR, line 32||5.|
|6.||Enter any tuition and fees deduction from Form 1040, line 34, or Form 1040A, line 19||6.|
|7.||Enter any domestic production activities deduction from Form 1040, line 35, or Form 1040NR, line 33||7.|
|8.||Enter any foreign earned income exclusion and/or housing exclusion from Form 2555, line 45, or Form 2555-EZ, line 18||8.|
|9.||Enter any foreign housing deduction from Form 2555, line 50||9.|
|10.||Enter any excludable qualified savings bond interest from Form 8815, line 14||10.|
|11.||Enter any excluded employer-provided adoption benefits from Form 8839, line 30||11.|
|12.||Add the amounts on lines 3 through 11||12.|
|13.|| Enter: ||13.|
| Is the amount on line 12 more than the amount on line 13? |
If yes, see the note below.
If no, the amount on line 12 is your modified adjusted gross income for Roth IRA purposes.
My MAGI was only $86,606, which is basically wages, interest, business income, and capital gains. The reason it's lower than my gross income is those lovely pre-tax deductions: my 401k, maxed out at at $15,500, plus little things like my monthly Metrocards, and health insurance.
For 2008, the MAGI limit for contributing the maximum $5,000 to a Roth IRA is $101,000 for individuals. (Yeah, it's different for you over-50 people and married-filing-jointly types, see the IRS link for details while the young swinging singles read on!) I plan to continue to max out my 401k contributions so hopefully it will still be a couple of years before I have to start limiting my Roth IRA amounts. But I will be using that worksheet each year from now on, just in case.
Fortunately, having a too-high income doesn't necessarily disqualify you from participating in a Roth IRA-- the contribution limit is lessened and eventually phased out as your income gets higher, it's not all or nothing. The IRS provides a worksheet with which you can calculate your correct maximum amount.
Here's an example of the 2007 worksheet for someone whose MAGI is over the limit, showing how to calculate the reduced contribution amount:
|1.||Enter your modified AGI for Roth IRA purposes||1.||100,000|
|2.|| Enter: ||2.||99,000|
|3.||Subtract line 2 from line 1||3.||1,000|
|4.|| Enter: ||4.||15,000|
|5.||Divide line 3 by line 4 and enter the result as a decimal (rounded to at least three places). If the result is 1.000 or more, enter 1.000||5.||.067|
|6.|| Enter the lesser of: ||6.||4,000|
|7.||Multiply line 5 by line 6||7.||268|
|8.||Subtract line 7 from line 6. Round the result up to the nearest $10. If the result is less than $200, enter $200||8.||3,740|
|9.||Enter contributions for the year to other IRAs||9.||0|
|10.||Subtract line 9 from line 6||10.||4,000|
|11.||Enter the lesser of line 8 or line 10. This is your reduced Roth IRA contribution limit||11.||3,740|
So what happens if you accidentally contribute more than you are allowed for your income level? You have to pay the IRS a 6% excise tax on the excess contribution amount. If you leave the money in the Roth IRA account anyway, it will reduce the amount, if any, which you are eligible to contribute the next year. If you aren't eligible to contribute anything the next year, then you'll keep getting dinged that 6% penalty each year the over-contribution remains in your account. Ouch!
Remember, all this tax stuff is serious business, and I am not a professional-- make sure you check the IRS website to do your own research for your own situation, and stay up to date on any changes in the laws!