This week, Gail discusses how to navigate the income limits that determine which IRA you can contribute to.

Hi, Gail-

We’re in the process of deciding where to invest our 2006 IRA contributions. My wife and I haven’t been able to contribute to Roth IRAs because of the annual income limit. All we’ve been able to do is make non-deductible contributions to regular IRAs.

However, I vaguely remember that legislation was passed last year raising the limits on Roths. Does this mean my wife and I may now qualify?

Or, since she is a full-time mom, is there any possibility that at least her IRA contribution would be deductible?

I make about $190,000/year and put as much as I can into my company’s 401(k), but everything I read (including your column!) tells me to save as much as possible for retirement.

Thanks,
Dan

Dear Dan-

I’m sorry to disappoint you, but you have the happy “problem” of earning too much to qualify for Roth IRAs. The only option for you and your wife is to again make after-tax contributions to traditional IRAs.

There are several issues here and the way they interact can be confusing. They are the facts that: 1) you’re married and, 2) only one of you works outside the home, and 3) the spouse who earns the family income participates in a retirement plan through his employer.

I’ll try to explain this simply. I will assume the two of you file “married, joint” and that you are under age 50. (1) There are different rules if you are married and file separate returns. (For details, visit the IRS Web site, www.irs.gov and look up “Publication 590.”)

If Neither Spouse Has a Retirement Plan Through Work: Income Isn’t a Factor

First of all, regardless of your income, and who earns it, if neither of you is covered by a retirement plan provided by an employer, you are each entitled to make a tax-deductible contribution to a traditional IRA.

If One or Both Spouses are Covered by an Employer Plan: Income Matters

If one (or both) of you is a participant in a company-sponsored retirement plan — even for part of the year — then the ability of the covered spouse to deduct his/her IRA contribution depends upon your joint income.

In order to make the maximum contribution for 2006 ($4,000) (2), your “modified adjusted gross income” (MAGI) cannot be more than $75,000. A portion of your contribution will be deductible if your MAGI falls between $75,000-84,999. Once your MAGI hits $85,000, your IRA contribution is no longer deductible.

If Only One Spouse Participates in an Employer Plan: Income Matters

In this case, the spouse who does not have a retirement benefit through a job may be able to deduct her/his IRA contribution.

This is your situation, Dan. Since your wife does not work outside the home, she is clearly not covered by an employer-sponsored retirement plan. In this case, for 2006, her IRA contribution (but not yours) would be deductible if your combined modified AGI were $150,000 or less. There’s a partial deduction up until your MAGI hits $160,000, at which point this is completely phased out.

Roth IRA Income Limits Adjusted

You heard correctly: after being stuck at the same level for10 years, the income limits that determine who is eligible to contribute to a Roth IRA have (finally) been adjusted for inflation. However, this only pertains to Roth contributions made for tax year 2007 or later.

In other words, if you want this to be considered a 2006 contribution, a married couple filing a joint return must be $150,000 or less. Once your modified AGI hits $160,000, the ability to contribute to a Roth phases out.

To be eligible to make a Roth contribution for the 2007 tax year, the modified adjusted gross income limit for those filing married/joint is $156,000. This phases out at $166,000. For single taxpayers, this has been increased to $99,000 to $114,000.

Notice that there is no income limit that prevents someone from contributing to a “regular” (non-Roth) IRA, even if, like you, they have a retirement plan through their job. The only thing that is affected by how much money you earn is whether your contribution is tax-deductible.

Even though you and your wife cannot deduct your IRA contributions, I strongly recommend you make them, for a couple of reasons. First, as you point out, the more you’re able to sock away for your retirement years, the more secure you’ll be.

According to the American Society of Actuaries, if you retired today and were both age 65, there’s a one-in-four probability that you’ll each live into your 90s.

In fact, there’s a 25 percent probability that one of you will reach age 97!

Second, as I’ve written previously, in 2010 the income cap that limits who is able to convert traditional IRA assets to Roth IRA assets will be eliminated.

Once in a Roth IRA, your investments will grow tax-free.

Any IRA contributions that you have already paid income tax on will not be taxed again when you convert. So all the years you’ve contributed after-tax money to a traditional IRA (because that was the only IRA option available to you) will reduce the total amount you’ll pay tax on if you decide to convert.

Hope this helps!
Gail

(1) Technically, the rule is $4,000 or your taxable income for the year, whichever is less.

(2) If either spouse is age 50 or older, you can contribute an additional $1,000 to whatever type of IRA you qualify for.

If you have a question for Gail Buckner and the Your $ Matters column, send them to: yourmoneymatters@gmail.com, along with your name and phone number.