Roth IRA Income Rules and Restrictions

What are the Roth IRA income rules and restrictions?

That's a great question. After all, the IRS doesn't allow just anyone to open and fund a Roth IRA.

You need to have the right type of income as well as the right amount of income.

Did you catch that?

The type of income you earn directly impacts your ability to make a Roth IRA contribution. You can't just fund your Roth IRA with any type of money you have access to. And that's not all, your contributions are subject to additional income restrictions as well.

So let's take a closer look at some of those Roth IRA income restrictions and how they impact your bottom line...

Type of Income For A Roth IRA

You can only use certain types of income to fund your Roth IRA.

According to the Roth IRA income rules, those types of income include most "earned income" you generate during the course of the year by working as an employee, selling products, providing services, etc. In contrast, income such as retirement or disability pension income, rental property income, interest, dividends, and other types of "passive" income do NOT qualify for purposes of making a Roth IRA contribution.

According to IRS Publication 590, eligible compensation includes the following...

"Wages, salaries, tips, professional fees, bonuses, and other amounts received for providing personal services. It also includes commissions, self-employment income, nontaxable combat pay, and taxable alimony and separate maintenance payments."

For instance, let's say you're 75 years old and receive $45,000 a year in pension benefits and social security. Can you contribute to a Roth IRA?

No. Not on the basis of your pension income and social security benefits alone.

However, let's say you take on a part-time job as a Wal-Mart greeter, earning $4,000 per year. Can you contribute to a Roth IRA now?

Yes. Because the wages and salary you receive from the Wal-Mart job are eligible for Roth IRA contributions.

Does that make sense?

Generally speaking, compensation is what you earn for working. That typically includes...

• Wages, salaries, etc.
• Commissions
• Self-employment income
• Alimony and separate maintenance
• Non-taxable combat pay

However, it does NOT include...

• Earnings and profits from property
• Interest and dividend income
• Pension or annuity income
• Deferred compensation
• Income from certain partnerships
• Foreign income
• Any amounts you exclude from income

If you can't easily fit your income to one of these categories, then it's probably good idea to talk to your account or a professional tax attorney before making a Roth IRA contribution.

Roth IRA Income Restrictions

In addition to the type of Roth IRA income the IRS requires, you also face a number of limiting factors in regard to the amount of income you can earn.

As a general rule, you can NOT contribute...

• More than you earn
• More than the established IRS limits
• The maximum amount if you're subject to a contribution phase out

Let's take a closer look at each of these limitations...

1) More Than You Earn - It should be obvious, but it needs to be said... You can't contribute more to your Roth IRA than you earn.

While the maximum contribution limit for your age may be $5,000, you can't make a $5,000 Roth IRA contribution if you only earned $4,000 during the course of the year. In such a scenario, the maximum amount you can contribute is $4,000, or 100% of your earnings.

For instance, let's say your teenage daughter earns $3,000 working as a lifeguard over the summer. Between Christmas and her birthday, her grandparents give her $1,200. Even though your daughter has the ability to fund her Roth IRA to the tune of $4,200, the most she can legally contribute is $3,000.

Why? Because that's the amount of her total compensation for the year, and gifts don't count as earned income or compensation.

2) More Than The IRS Limits - You can NOT contribute more than the Roth IRA income limits allow. Currently, the IRS places limits on the amount of your annual contribution as well as who can contribute based on earned income.

For instance, your annual contribution must adhere to the following limits...

• $5,500 if you're under 50 years old
• $6,500 if you're 50 years old or older

The higher limit kicks in for the year in which you turn 50. So if you spend most of 2013 as a 49 year old and then turn 50 years old on December 31st, you can still make a $6,500 maximum contribution for the year 2013.

In addition to the maximum contribution, the IRS places restrictions on whether you can or can not contribute to a Roth IRA based on your modified adjusted gross income (MAGI). These limits put a cap on who can make a Roth IRA contribution.

The income limits are as follows...

• $188,000 if you're married filing jointly
• $127,000 if you're single or head of household
• $10,000 if you're married filing separately but still live with your spouse

If your income exceeds the maximum threshold, you are ineligible to make a Roth IRA contribution for the current tax year. However, this does NOT exclude you from making a contribution in any future year if your income falls below the threshold.

3) Subject To A Contribution Phase Out - Even if your income falls below the threshold for making a Roth IRA contribution, you may still be subject to a cap on the amount you can contribute. As you earn above a certain amount of income, your contribution limit gradually phases out from the maximum amount to zero.

The Roth IRA income phase out range is as follows...

a) If you're married filing jointly - Your maximum contribution limit phases out when you earn between $178,001 and $188,000.

b) If you're single, head of household, or married filing separately (and did NOT live with your spouse for any portion of the tax year) - Your maximum contribution limit phases out when you earn between $112,001 and $127,000.

c) If you're married filing separately (and did live with your spouse for any portion of the tax year) - Your maximum contribution limit phases out when you earn between $1 and $10,000.

If your income falls within the phase out range, read Roth IRA Phase Out in order to calculate the maximum amount you're eligible to contribute.

Conclusion

The IRS imposes Roth IRA income restrictions on your ability to contribute to a Roth IRA. As such, it's important to know what those rules and restrictions are and how they effect you.

First and foremost, remember that not all Roth IRA income is created equal. You must have "active" earned income from working or producing in the current tax year in order to contribute. Supplemental, "passive" forms of income are NOT eligible.

In addition, you need to take note of the limits placed on annual Roth IRA contributions, the amount of earned income you can generate while maintaining your eligibility, and the existence of contribution phase out rules if your income falls within a predetermined range.

Abide by these rules, and you should avoid any problems with the IRS. Ignore them, and you might be subject to penalties, taxes, or both.