How to Determine Roth IRA Contribution Eligibility
By Jodie Norquist
Last month The Link examined Traditional IRA contribution eligibility. But what about the Roth IRA? Sometimes viewed as the younger sibling to the Traditional IRA, the Roth IRA offers distinct tax advantages that set it apart within the IRA family. One distinction is that contributions go into the Roth IRA as after-tax money; whereas Traditional IRA contributions are funded as pretax money for those who qualify for income tax deductions. Probably the biggest draw to the Roth IRA is that distributions are tax-free, including the earnings, if the Roth IRA owner meets the requirements for qualified distributions.
Some individuals may not meet the eligibility requirements for Roth contributions. While it is the responsibility of the individuals to determine their eligibility, as an IRA trustee or custodian, you can better assist your clients if you understand these rules.
Two Eligibility Requirements
Individuals must meet two eligibility requirements to contribute to a Roth IRA.
1. They must have earned income.
2. They must have modified adjusted gross income (MAGI) below a certain limit.
Roth IRAs are designed as a retirement savings vehicle for individuals who are working (or have a working spouse) and earn income that falls under MAGI limitations set by the IRS. If individuals or married couples make too much money, they won’t qualify to make Roth IRA contributions. But even if they don’t qualify to make Roth IRA contributions, they may still be able to invest in a Roth IRA with retirement plan rollovers or Traditional IRA conversions.
Earned Income
Eligible compensation—generally earned income—is required during the year for which an individual would like to make a Roth IRA contribution. The individual, or spouse if married filing a federal joint income tax return, must have enough earned income to equal or exceed his (or the couple’s) total IRA contribution amounts.
Earned income includes wages, salaries, tips, professional fees, bonuses, and other amounts received from working. It may also include commissions, self-employment income, nontaxable combat pay, military differential pay, and, as of January 1, 2020, “difficulty of care” payments and certain payments to graduate and postdoctoral students. Ineligible compensation to fund a Roth IRA generally includes earnings and profits from property and investments, such as rental income, interest income, and dividend income. Any foreign earned income is excluded. Social Security, pension, annuity, and any other retirement income also does not qualify as eligible compensation.
One way for a taxpayer to determine her earned income is to see the “Wages, tips, other compensation” box, reduced by any amount shown in the “Nonqualified plans” box on IRS Form W-2, Wage and Tax Statement, according to IRS Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs). But non-W-2 income from services legitimately rendered qualifies too.
Roth IRA Contribution MAGI Limits
Roth IRA contribution eligibility depends on an individual’s income (or, if married, the individual and spouse) and tax filing status. Here are the 2019 and 2020 MAGI limits.
Individuals who have MAGI that is equal to or less than the applicable lower amount of the phase-out range may make the maximum statutory contributions ($6,000 for 2019 and for 2020, plus $1,000 annual catch-up contribution if age 50 or older). Those with MAGI equal to or more than the maximum amount in the range cannot make any Roth IRA contributions. And those who fall within the phase-out range can make contributions on a pro rata basis.
IRA owners with MAGI in the phase-out range will need to calculate their maximum allowable regular contributions by using the Maximum Roth IRA Contribution Worksheet in the instructions for IRS Form 8606, Nondeductible IRAs. Alternatively, the IRS provides a formula to do this calculation. The formulas for married individuals filing jointly and single filers follow, with an example.
Married Individual Filing a Joint Return: 2019
Single Individual: 2019
*$6,000 plus $1,000 for individuals who turn age 50 or older in the year for which the contribution is made.
EXAMPLE
Dorothy, age 44 and single, has MAGI of $126,000 for tax year 2019. The maximum amount she may contribute to a Roth IRA will be calculated as follows.
Dorothy may contribute $4,400 to her Roth IRA for 2019.
Contribution Deadline
The deadline for making a Roth IRA contribution is the IRA owner’s federal income tax return due date (April 15 for most taxpayers) not including extensions. If this deadline falls on a Saturday, Sunday, or legal holiday, the IRA owner has until the following business day to make the prior-year contribution. If the IRA owner makes a contribution between January 1 and April 15 for the previous tax year, she must make such election in writing to the financial organization before that tax due date. IRA owners should get assistance from competent tax advisors to help them determine their Roth IRA contribution eligibility.
