Advantages of a Roth IRA that compared to a traditional IRA include tax-free qualified distributions and the ability to withdraw any amount of your principal penalty-free. Also, Roth IRA’s do not have a required minimum distribution after age 70½ as there is with a traditional IRA. Let’s learn more about income limitations for holding a Roth IRA, contribution limits (and special rules for individuals over 50). You’ll also learn about alternative options for getting the benefits of a Roth IRA if you’re earning more than the Roth IRA limitations.
You Need Earned Income
Any individual with earned income can open a Roth IRA. The most common forms of earned income (compensation) are taxable money earned from working for an employer or net earnings made by someone who is self-employed. Other income that can be used to fund a Roth IRA includes:
Taxable alimony or other maintenance received under a divorce decreeNontaxable combat payCertain taxable non-tuition and stipend payments
Money that is not considered compensation by the IRS and cannot be used to fund an IRA account includes:
Earnings and profits made from property, such as rental income Pension or annuity income Deferred compensation Nontaxable alimony or maintenance Unemployment benefits
You can participate in an employer-sponsored qualified retirement plan such as a 401(k) or 403(b) and remain eligible to open and fund an IRA if they meet all other requirements for IRAs.
Roth IRAs Income Limits
Roth IRAs were created by the Taxpayer Relief Act of 1997. Lawmakers set income limits to prevent high-earning individuals from using them as tax shelters. Eligibility to contribute to a Roth IRA is based on household income. The IRS routinely adjusts the MAGI limits and the contribution limits for inflation. The contribution limits for 2022 are: Using a backdoor strategy, you contribute to a traditional IRA, which has no income limits. Then you convert that to a Roth IRA. A backdoor Roth IRA strategy is similar to a Roth conversion, but it allows an individual to contribute to a Roth year after year for decades if they choose, whereas Roth conversions occur all at once or using a Roth conversion ladder method. Matthew Mancini, a senior wealth planner at Wilmington Trust’s Emerald Family Office and Advisory, told The Balance in a phone interview that he thinks the backdoor Roth strategy is an excellent long-term retirement savings approach, especially for younger people with longer investing horizons.
Roth IRA Age Limits
A basic tenet of investing is that time is an investor’s best friend. With that in mind, a Roth IRA can be used as a powerful savings tool for young people earning money. There is no age limit for someone to open a Roth IRA. The only requirement is that it must be funded with earned income. A teenager who earns money through a part-time job like babysitting can fund a Roth IRA up to the amount they earn or the contribution limit. As Mancini explained, the IRS doesn’t care where the funds deposited in a Roth IRA come from as long as the account holder has earned that amount. So, a teenager who earns $3,500 through a summer job could use that money for other purposes while the child’s parent or grandparent contributes the $3,500 to the teen’s Roth IRA. Mancini said many people do not take advantage of opening an account for a minor, or using the backdoor Roth strategy. in part because they never explored Roth IRA options due to their high income precluding them from contributing to a Roth themselves. Keep in mind the IRS has implemented a five-year rule for Roth IRA that stipulates any earnings can be withdrawn from a Roth tax-free and penalty-free if it has been five years since you first contributed to the account and you meet one additional qualifying factor, such as being 59½ or older.
Roth IRA Contribution Limits
The IRS sets a limit to the amount that can be contributed to an IRA annually – $6,000 in 2022 or $7,000 if you’re over age 50. This amount is adjusted by the IRS regularly (but not every year) to account for inflation. This maximum applies to all IRAs an individual holds. Thus, if they have both a traditional IRA and a Roth IRA, they can only deposit the maximum amount allowed during that tax year. They cannot deposit the maximum into each of the IRAs. You can contribute the maximum amount each year, but then the contribution limit declines at a certain level of household AGI. For 2022, the Roth IRA contribution limit is reduced or eliminated in the following situations:
You are filing with a “married filing jointly” status or as qualifying widow(er) and your MAGI is at least $204,000 to $214,000. Once your MAGI is $214,000 or more, you can’t make a contribution. You are filing status as “single, head of household” or “married filing separately,” you didn’t live with your spouse at any time in 2022 and your modified AGI is at least $129,000 to $144,000. After that, you can’t make contributions. You are “married filing separately,” you lived with your spouse at any time during the year, and your modified AGI is from $0 to $10,000. After that, you can’t make a Roth IRA contribution.
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