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Roth IRA Contribution Rules

What are the Roth IRA contribution rules?

How much can you contribute?

Do you qualify to make a contribution at all?

And how much can you contribute if you do?

These are the questions you should be asking if you're new to the world of Roth IRAs.

Generally speaking, the rules regarding Roth IRA contributions break down into the following categories:

  • Earned Income Rules
  • After-Tax Contribution Rules
  • Contribution Income Limit Rules
  • Maximum Contribution Rules

Each of these elements effects your ability to make a Roth IRA contribution, so learn them inside-and-out.

The Roth IRA Contribution Rules

Earned Income Rules

The Roth IRA contribution rules require you to make contributions from eligible taxable compensation only.

So what does that mean?

According to the IRS, eligible taxable compensation includes:

  • Wages
  • Salaries
  • Tips
  • Professional Fees
  • Commissions
  • Self-Employment Income
  • Nontaxable Combat Pay
  • Taxable Alimony
  • Bonuses, and
  • Other Amounts Received for Providing Personal Services

Eligible taxable compensation does NOT include:

  • Pension Income
  • Annuity Income
  • Social Security
  • Interest Income
  • Dividends
  • Foreign Income, and
  • Any Amounts Excluded from Taxable Income

So under the Roth IRA contribution rules, only a certain type of income is eligible for making a contribution.

For example, let's say you're 71 years old and you make $36,000 per year - $18,000 from your pension, $12,000 from Social Security, and $6,000 from interest and dividends.

How much can you contribute to your Roth IRA?

Nothing.

Why?

Because none of your income (pension, social security, and interest/dividends) qualifies as eligible compensation for the purposes of making a Roth IRA contribution.

As a result, you can't contribute a single dollar to your Roth IRA.

However, if you get a part-time job, most likely you will be eligible to make a contribution.

After-Tax Contribution Rules

Once you have eligible earned income, the Roth IRA contribution rules require you to make any contributions with after-tax dollars.

This means that any contributions you make are NOT tax deductible.

For example, let's say you earn $40,000 and you're in the 20% income tax bracket.

If you contribute $5,000 to your 401k, your contribution is tax deductible, so you make your contribution before you pay taxes.

The end result is $40,000 - $5,000 = $35,000 * 25% = $8,750 in taxes paid, and you end up with $5,000 in your 401k and $26,250 in take-home pay.

But if you contribute $5,000 to your Roth IRA instead, your contribution is not tax deductible, so you make your contribution after you pay taxes.

The end is $40,000 * 25% = $10,000 in taxes paid before your $5,000 Roth IRA contribution, and you end up with $5,000 in your Roth IRA and $25,000 in take-home pay.

While at first glance it seems like the 401k is the better deal because you end up with more take-home pay, remember withdrawals from a Roth IRA are tax-free, while withdrawals from a 401k are fully taxable.

Contribution Income Limit Rules

The Roth IRA contribution rules also dictate the amount of income you can earn and remain eligible to make a Roth IRA contribution.

Under rules established by the IRS, you can make the maximum annual Roth IRA contribution up to the following limits:

  • $169,000 if you're married filing jointly
  • $107,000 if you're single or head of household
  • $0 if you're married filing separately and you lived with your spouse for any part of the year

These are the limits for making the maximum contribution.

If you earn more than the income levels above, then your maximum allowable contribution phases out to zero according to the Roth IRA income rules.

For instance, let's say you're married with a combined income of $170,000.

Are you prohibited from making a Roth IRA contribution?

No.

However, you are prohibited from making the maximum annual contribution for your age since you earned $1,000 more than the income limit for your tax filing status.

As a result, your maximum contribution limit is a percentage of the maximum allowable contribution for someone your age, with the percentage being determined by the Roth IRA phase out rules.

But assuming you qualify to make the maximum Roth IRA contribution, what exactly is it?

Maximum Contribution Rules

Under the Roth IRA contribution rules, you can make a maximum annual Roth IRA contribution of:

  • $5,000 if you're under 50 years of age, or
  • $6,000 if you're 50 years old or older

To qualify as 50 years old or older, you must turn 50 years old in the calendar year of your Roth IRA contribution.

For instance, if your birthday in on December 31st of 2015, then you can make the maximum $6,000 Roth IRA contribution for the 2015 tax year anytime from January 2nd of 2015 until April 15th of 2016.

In addition, the Roth IRA contribution rules state that you can NOT contribute more to your Roth IRA than you earn in eligible taxable compensation for the year.

For example, let's say you're 17 years old with $4,000 in earned income.

You can't contribute $5,000 to your Roth IRA, even though the maximum annual contribution limit for someone under age 50 is $5,000.

The most you can contribute is however much you made in earned income - in this case $4,000.

Contribution Rules for Roth IRAs

The IRS established Roth IRA contribution rules you must follow if you wish to avoid any taxes or penalties resulting from a violation.

Make sure you can answer "yes" in agreement with each of the following statements:

  • You generated eligible taxable earned income
  • You funded any Roth IRA contributions with after-tax dollars
  • Your income did not exceed the limits for making a contribution
  • Your Roth IRA contributions did not exceed the allowable limit
  • As long as you're in compliance with these Roth IRA contribution rules, you're in good shape.

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