Monday, October 26, 2009

Roth IRAs may be an option

On Mondays, we answer a question from a reader in this space. If you have a question, please post it in the comments section or e-mail it to

QUESTION: I’d like to make a ROTH IRA contribution for me and for my husband - $5,000 each in 2009. However, my husband’s income is about $60,000 and mine will probably be at least $100,000. I’m self-employed. I understand from what I’ve read about Roth IRAs that if your Modified Adjusted Gross Income is $166,000 you can’t make the contribution. If our income comes in at or right above $166,000, does that mean that we won’t qualify? What’s modified adjusted gross income anyway?

ANSWER FROM DAN DANFORD: This may sound like a simple question, but really, it's not. The Modified Adjusted Gross Income is a complex number that depends on many factors, and I don't know enough about your personal situation to tell if you'll be disqualified or not, especially since your income is near the borderline. Here's a link to solid information to read more about it:

Despite the income limitations, Roth IRAs are worth taking the time to do the calculations to ensure that you qualify. Roth IRA accounts differ from traditional IRAs because there's no tax deduction for the annual contributions. In other words, it's money that has already been taxed. The desirable Roth benefit is that you won't pay taxes on the annual portfolio growth or withdrawals in retirement. There are a number of constraints - including family income and early withdrawal privileges - which alter the ability and attractiveness for using Roths.

I'm not going to address the exact Roth tax rules here. You'll need to talk that over with your tax advisor who knows your exact situation including income and adjustments. But some general guidelines might be helpful. First, the younger you are, the more attractive a Roth. Income and tax rates aren't high, so the tax you pay isn't prohibitive. A traditional IRA deduction isn't as meaningful for you. Second, the period for tax-deferred compounding is longer, so that's appealing, too. Third, the older you are, the more likely you are to have existing traditional IRA accounts. Why complicate life with another tier of monthly paperwork?

I'm a fan of Roth IRA accounts in the right circumstances, and your family could be a perfect fit. You've got high income and 401(k) or traditional IRA tax deductions could be more appealing. Also, I'd usually suggest a compounding table to view the actual difference between Roth compounding and traditional compounding, given your age and years until retirement. It's true that you'll pay taxes on withdrawals with the traditional, but most of our clients defer those withdrawals for a very long time anyway. Not sure how much difference the Roth makes for many people.

Overall, I'd suggest you discuss with your tax advisor and keep one eye towards convenience and simplicity. I see too many people with a dozen scattered accounts which include Roth, traditional, old 401(k)s, and an occasional orphaned Tax Sheltered Annuity. Stick to a good long-term plan, and weigh both current and future tax breaks.

Your best plan for 2009 may be to wait until as late as you can in 2009 when you'll know, as a self-employed person, what your gross income will be. Ask your tax advisor to help you figure out your MAGI and see if you'll qualify. Hold on to the Roth IRA money until then, and make the contribution in December if you qualify. If you aren't working with an advisor, you need to be. With your income, you can make some significant progress towards long-term goals if you have professional help. This is an opportunity you don't want to squander.

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