Qualifying for Making Roth IRA Contributions

Contributions to a Roth IRA go in as after-tax money, and distributions are generally tax-free.

The Roth IRA custodian does not determine if the Roth IRA contribution is eligible or not. Instead, the onus falls on the individual to determine her eligibility.

Eligibility Requirements

  1. Must have earned income
  2. Must have modified adjusted gross income (MAGI) below a certain amount

Earned Income

Those who are working generate earned income. Roth IRAs are for individuals with earned income (e.g., W-2 wages, salaries tips, bonuses and other amounts received from working). Earned income is required in  the year the individual wants to make a Roth IRA contribution. If one spouse has earned income and the other does not,  the spouse with no earned income can use his spouse’s income to make Roth IRA contributions provided the married couple file a joint tax return.  Earned income does NOT include investment income from stocks or real estate, for example. Additional income NOT considered eligible for making Roth IRA contributions includes social security, retirement income (e.g., annuity, pension, etc.), and foreign earned income.

MAGI Limits

Another factor in determining if the individual can make Roth IRA contributions is how much earned income the individual or his spouse generates and has to be below a certain limit. This amount is known as modified adjusted gross income (MAGI).

The phase-out range varies each year. Depending on the MAGI amount, the individual can contribute the full or some of the annual Roth IRA limit. Those with MAGI equal to or more than the maximum amount in the range cannot make any Roth IRA contributions. If the individual thinks she may fall within the phase-out range, use the Maximum Roth IRA Contribution Worksheet in the instructions for IRS Form 8606, Nondeductible IRAs to determine the Roth IRA contribution amount. CLICK HERE to view the phase-out range.

Deadline to Make Contributions

The Roth IRA contribution deadline is the individuals federal income tax return due date (April 15).  The contribution can be made for the prior tax year if made between January 1 and April 15.

Partial Roth IRA Conversion to Start the 5 Year Clock QUESTION: 

I have a friend that already has a self-directed IRA, but he needs a Roth. Can he Rollover a small sum (and pay the taxes)to establish the new account to get past the 5 year rule regarding withdrawals? He is 65 and wants to be able to pull the money if he needs to. 

ANSWER:  

Yes a pretax IRA can be partially converted to a Roth IRA. In addition to funding a Roth IRA via an annual contribution, a Roth IRA can be funded via a conversion from a Traditional IRA and no minimum or maximum threshold applies to conversion amounts. If funded by converting traditional IRA funds, the amount converted is taxable in the year converted,  but not subject to the 10% early distribution penalty even if the IRA account colder is under age 59 1/2 at the time of the conversion.  

As far as the 5 year Roth distribution holding period rule, all distributions from Roth IRAs are considered tax and penalty free if they satisfy the “qualified” Roth IRA distribution rules.  To be deemed a “qualified” distribution, two requirements must be satisfied. First, the Roth IRA must be 5 years old, with the period beginning January 1 of the year for which the Roth IRA owner makes his first Roth IRA contribution. The Second requirement is one of the following: 

  • Age 59 1/2 or older
  • Disability
  • Death
  • First-time home buyer

The 5 year period works to the IRA owner’s benefit in that only one period applies to all of his Roth IRAs starting with the first Roth IRA that received a contribution. What is also interesting is that if the IRA owner distributes all of his Roth IRA funds and later makes contributions to a Roth IRA, the 5-year clock does not start over with the new contribution. 

For those Roth IRA owners who do not meet both the 5-year clock and one of the additional requirements discussed above (e.g., the age 59 1/2 or older rule, etc) but still chooses to take a distribution, the distribution will be considered a “non-qualified” distribution. When a Roth IRA distribution is considered ” non-qualified,” the earnings (the pretax funds) that are distributed are treated as taxable income and subject to the 10 percent early distribution penalty unless the IRA owner is age 59 1/2 or older. However, the Roth IRA basis is not taxable and will be first distributed under the Roth IRA rules, but will be subject to the 10% early distribution penalty if the IRA owner is under age 59 1/2 unless he qualifies for one of the 10% early distribution penalty waivers

About Mark Nolan

Each day I speak with energetic entrepreneurs looking to take the plunge into a new venture and small business owners eager to take control of their retirement savings. I am passionate about helping others find their financial independence. Having worked for over 20 years with some of the top retirement account custodian and insurance companies I have a deep and extensive knowledge of the complexities of self-directed 401ks and IRAs as well as retirement plan regulations. Learn more about Mark Nolan and My Solo 401k Financial >>

MENU