Not everyone can use a Roth IRA to save for retirement, however. The IRS determines who can contribute to a Roth IRA based on income and tax filing status. Learn who can contribute to a Roth IRA and more about annual contribution limits.
Who Can Open and Contribute to a Roth IRA Account?
Generally speaking, someone needs to have compensation to open and contribute to a Roth IRA. For IRS purposes, compensation includes:
WagesSalariesTipsProfessional feesBonusesOther amounts received for providing personal servicesCommissionsSelf-employment incomeNontaxable combat payMilitary differential payTaxable alimony and separate maintenance payments
Disability benefits don’t count as income for Roth IRA eligibility. The income requirement for Roth IRAs is the same as for traditional IRAs. The main difference between a Roth IRA and a traditional IRA is their tax treatment. A traditional IRA is funded with pretax dollars and contributions may be tax-deductible. But unlike a Roth, you’ll pay taxes on the money when making qualified distributions in retirement. A Roth IRA accepts contributions on income that has been taxed. When you make the withdrawals in retirement years, they are not subject to income tax. The main advantage of a Roth IRA is that the gains your investments make are also not taxed as income.
How Does Your Income Affect Roth IRA Eligibility?
The IRS bases your eligibility to open and contribute to a Roth IRA on your income and tax filing status. Specifically, this is based on your modified adjusted gross income (MAGI). Your MAGI is your adjusted gross income plus any untaxed foreign income, non-taxable Social Security benefits, and tax-exempt interest. The income limits are updated each year. If your income exceeds the allowed limit for your filing status, you can’t contribute to a Roth IRA. Additionally, the amount you can contribute to a Roth IRA begins to phase out once your income exceeds certain limits. Here’s how basic income levels are set for single and married couples filing jointly for 2022.
What Else You Need To Know About Roth IRA Contributions
Aside from understanding who can contribute to a Roth IRA based on income, there are a few other things to keep in mind about these accounts.
Annual Contribution Limits
Roth IRA contributions are not unlimited. The IRS only allows you to contribute so much per year. Whether you can make the full contribution will depend on your income and filing status.
Workplace Plan Contributions
Contributing to a workplace retirement plan doesn’t prevent you from saving money in a Roth IRA or affect how much you can contribute, as long as you’re income-eligible. If you have a traditional IRA, on the other hand, the amount of your contributions that you can deduct is determined in part by whether you have a retirement plan through your employer.
Taxation of Distributions
Qualified withdrawals from a Roth IRA are tax-free if you’re at least age 59 ½ and meet the five-year rule. This rule says your account must be open for at least five years before penalty-free withdrawals can be made. You can also withdraw original contributions from a Roth IRA without a tax penalty. Early distributions of earnings, however, may be subject to a 10% early withdrawal penalty unless you qualify for an exception. For example, you can withdraw up to $10,000 toward the purchase of a first home penalty-free.
Excess Contributions
Making excess contributions to a Roth IRA above what’s allowed for your income and failing status can result in a tax penalty. Excess contributions are subject to a 6% excise tax each year they remain in your account.
Roth IRA Conversion
If you’re not able to contribute to a Roth IRA because of your income, you have alternatives. You could do a Roth IRA conversion, which is sometimes referred to as a backdoor Roth. With a Roth IRA conversion, you open and contribute to a traditional IRA, then roll that money over to a Roth IRA. This allows you the tax benefits of a Roth in retirement, regardless of income. Keep in mind, however, that the IRS taxes earnings on traditional IRAs that are converted.
