Modified Adjusted Gross Income (MAGI)

What is Modified Adjusted Gross Income (MAGI)?

How do you calculate it? And why is it important to know if you have a Roth IRA?

Those are all good questions, and if you have a Roth IRA, you've more than likely run into this term.

Why?

Because MAGI is used as the basis for determining whether or not you're eligible to contribute to a Roth IRA. And if you are eligible, it determines how much you can contribute to your Roth IRA.

For instance, if you're married filing a joint tax return, you and your spouse must have a combined MAGI of less than $176,000 in order to remain eligible to contribute to your Roth IRA. And this figure might well be quite different than the adjusted gross income (AGI) on your income tax forms.

So MAGI is an important number to know.

Since that's the case, let's take a closer look at its definition as well as how it's calculated.

What Is Modified Adjusted Gross Income?

Your modified adjusted gross income (MAGI) as it relates to your Roth IRA is nothing more than your adjusted gross income (AGI) as shown on your tax return, along with a few modifications.

For instance, when making a Roth IRA conversion or rollover, you must report any retirement account distributions as taxable income. Adding these distributions to what you've already earned makes your adjusted gross income (AGI) higher than it otherwise would be.

And since you can only make contributions to a Roth IRA with earned income compensation (and retirement income is NOT included in that definition), you need to subtract any withdrawals from your retirement savings plan when calculating your MAGI for purposes of determining your eligibility to contribute to a Roth IRA.

For example, let's say you're single with AGI of $150,000. The current upper limit for making a Roth IRA contribution is $120,000.

So, at first glance, it appears that you're ineligible to make a Roth IRA contribution.

Lucky for you, adjusted gross income is NOT the determining factor... modified AGI is.

For argument's sake, let's say you made a $3,000 tax deductible contribution to your Traditional IRA, and you performed a Roth IRA rollover from a retirement account with $50,000 in it.

Your MAGI subtracts the $50,000, since that needs to be taxed but is NOT current compensation income. It also adds back your tax deductible Traditional IRA contribution since that was made with current compensation income.

In this simplified example, your adjusted gross income may be $150,000. But your modified adjusted gross income is $103,000.

As a result, MAGI provides the IRS with a far more accurate figure of the compensation income you generated this year than does your adjusted gross income.

How To Calculate Modified Adjusted Gross Income

By now, we've determined that you need to know your modified adjusted gross income (MAGI) figure. Otherwise, you can't be sure if you're eligible to make a Roth IRA contribution.

So how do you calculate MAGI?

First, start with your adjusted gross income (AGI) as shown on your tax return. This is line 21 on IRS Form 1040A (U.S. Individual Income Tax Return).

From your AGI, subtract the following items if applicable...

1) Roth IRA Conversions - This includes any amounts listed on Form 1040, line 15b; Form 1040A, line 11b; or Form 1040NR, line 16b.

2) Roth IRA Rollovers - This includes rollovers from qualified retirement plans included on Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b.

3) Minimum Required Distributions - This includes any minimum required distributions from other IRAs (for conversions and rollovers from qualified retirement plans only).

Once you've subtracted these items from your AGI, you'll need add back the following deductions and/or exclusions...

a) Traditional IRA deduction
b) Student loan interest deduction
c) Tuition and fees deduction
d) Domestic production activities deduction
e) Foreign earned income exclusion
f) Foreign housing exclusion or deduction
g) Exclusion of qualified bond interest shown on Form 8815
h) Exclusion of employer-provided adoption benefits shown on Form 8839

Once you've added these items back to the aforementioned figure, you end up with your modified adjusted gross income (MAGI).

Whew! Seems needlessly complex, doesn't it?

Don't worry. If you find it too hard to follow those directions, you can use Worksheet 2-1 to figure out your MAGI.

Conclusion

If you earn anywhere near the income limits for making a Roth IRA contribution, then you need to know and calculate your modified adjusted gross income (MAGI).

Why?

Because even though your adjusted gross income (AGI) as listed on your IRS Form 1040 may fall below the income limit threshold, your modified adjusted gross income might be higher if you have to add back deducted items such as student loan interest and foreign earned income.

If that's the case, you want to avoid the possibility of making an excess Roth IRA contribution, which generates a 6% annual penalty until corrected.