IRA Contribution limits

[RunHappy]

I'm looking to open an IRA but am confused on what contribution limits mean.  From what I can tell a single person can contribute up to $5500 annually to a Roth or Traditional IRA, but Roth has "contribution phase out" for income levels over $114k annual gross income.  What if my AGI is more than $114k?  Does this mean I have go with a traditional IRA?

[Keekster]

If your filing status is single, the phase out for a Roth IRA begins with a MAGI (Modified Adjusted Gross Income) at 114k. Once your MAGI hits $120k, you are ineligible for a Roth IRA. MAGI is calculated by taking adjusted gross income from your tax forms and adding back deductions like student loan interest and higher education expenses.

So yes, once you reach the limitations, you will no longer be able to contribute to a Roth IRA.

[Keekster]

If your AGI is over a certain amount AND you are in a qualified retirement plan, your eligibility for a traditional IRA will phase out as well.

[skyrefuge]

If your MAGI truly exceeds the Roth limit (and be aware that your MAGI is likely a good bit lower than what you think of as your "salary", especially if you're maxing your 401(k)), then you cannot contribute directly to a Roth IRA.

However, since 2010, you can do a "backdoor" Roth IRA contribution, which has the exact same effect as a direct contribution. See http://www.bogleheads.org/wiki/Backdoor_Roth_IRA

This only really works if you don't already have money in a tax-deductible Traditional IRA, but since you're asking these questions, you probably don't, so you might be a perfect candidate for the Backdoor Roth.

If you're covered by a 401(k) at work, then you also won't be able to make tax-deductible contributions to a Traditional IRA. You can make non-deductible contributions, but the Backdoor Roth would be a better choice. If you're not covered by a 401(k), then a tax-deductible Traditional IRA might be a better choice.

[RunHappy]

Ok so just to make sure I understand.  My current salary is $120k/annually and I'm maxing out my 401k at 15% (or so). Then that will bring my MAGI to $102k, which makes me eligible for Roth.  What happens if I open a Roth and end up exceeding the MAGI would I need to convert it to a Traditional?  Should I just go ahead and start a Traditional and save me the headache?

[MDM]

The MAGI limits for (deductible) traditional are lower than for Roth.  See http://www.cffpinfo.com/pdfs/2014_Annual_Limits.pdf:
IRA deduction phaseout for active participants
     Single $60,000-$70,000
     Married filing jointly $96,000-$116,000
     Married filing separately $0-$10,000
     Spousal IRA $181,000-$191,000
Roth IRA phaseout
     Single $114,000-$129,000
     Married filing jointly $181,000-$191,000

If you over-contribute to a Roth, the simplest thing is to withdraw the money from that account and invest it in a taxable account.  E.g., see http://www.rothira.com/blog/what-to-do-if-you-contribute-too-much-to-your-roth-ira.

[secondcor521]

It sounds like you are single and covered by a retirement plan at work (your 401k).

For 2015, you can contribute the maximum amount ($5500) to a Roth IRA until your MAGI reaches $116K.  Above $116K and below $131K, you can contribute an amount between $0 and $5500.  This is called the phase-out range.  I believe but am not certain that it is a straight-line reduction, meaning that since the phase out range is $15K, for each $3K in additional income the amount you can contribute is reduced by $1100  ($15K / $5500 == $3K / $1100).  Above $131K, you cannot contribute to a Roth IRA.

If you end up contributing more than you are entitled to do, you can recharacterize the excess contributions (plus any associated earnings) from your Roth IRA to a traditional IRA; in that case no additional taxes are due.  You can also withdraw the excess contributions plus any associated earnings from your Roth IRA; if you do that you will owe taxes plus a 10% early withdrawal penalty on the earnings (but not the contribution) if you are under 59.5.  (You can technically leave it in the Roth IRA, but pretty much nobody ever does that because you have to pay 6% of the excess contributions every year that you leave the excess contributions in the Roth IRA.)

You can also go the other direction -- open and contribute the maximum to a traditional IRA, and then recharacterize some of your contribution (plus any associated earnings) to a Roth IRA.

Note that you can contribute to both accounts, so supposing you made $119K next year, you would be $3K into the phase out range, so you could contribute $4400 to a Roth and $1100 to a traditional.

There are time limits to doing the recharacterization; I don't recall offhand what they are.  I am nearly certain that you may recharacterize 2015 contributions any time before you file your taxes for 2015 in April of 2016.

Finally, note that although you can contribute to a traditional IRA with any income, you can only deduct your contributions from your income if your MAGI is below $71,000.  Based on your income, it looks like you would not be able to deduct a contribution to a traditional IRA.  Given that, a Roth would be a much better choice -- in either case you won't deduct the contribution, but with a Roth your withdrawals would be tax free but with a traditional IRA your withdrawals would be taxed at ordinary income rates.

[GrayGhost]

If you're planning to work a high-income job for a few years more years, one thing you might consider is creating a business that does whatever you want it to, and opening an SEP-IRA through that. You might need to do a bunch of research, or even employ an accountant, but the contribution limits are huge ($50k or something) so it's definitely worth looking into.

[wtjbatman]

Ok so just to make sure I understand.  My current salary is $120k/annually and I'm maxing out my 401k at 15% (or so). Then that will bring my MAGI to $102k, which makes me eligible for Roth.  What happens if I open a Roth and end up exceeding the MAGI would I need to convert it to a Traditional?  Should I just go ahead and start a Traditional and save me the headache?

Wait until the beginning of 2015, after you know what your MAGI actually is, before choosing to contribute to either the Roth or Traditional. You have until April 15th 2015 to make a contribution for tax year 2014.

[RunHappy]

Thanks everyone for the great responses.  I think I will wait until the first of the year to see what my real MAGI is.  Barring unforeseen circumstances (technology reverse, extreme sickness, zombies)  I am planning to be at this job until I reach FI (still many years away).

GrayGhost:  That sounds interesting, I will read more about it.

[Keekster]

Don't quote me on this, but I believe you can only contribute up to 25% of your earnings into the self employed retirement account. So, on income of $120k, the max you could contribute would be $30k.

[MDM]

Don't quote me on this, but I believe you can only contribute up to 25% of your earnings into the self employed retirement account. So, on income of $120k, the max you could contribute would be $30k.

See http://www.irs.gov/Retirement-Plans/Retirement-Plans-for-Self-Employed-People to quote the IRS.  There are a few "if this then that" things to consider.