Roth IRA Contribution Limits Designed to Screw With You

Hey everyone, I’m still alive.

Okay, with that brief acknowledgement out of the way, let’s move onto something serious: Roth IRA Contribution Limits. I know this is serious because I heard some guy complaining about it the other day while eating at the delicious SNOWLAB, which can only be eaten while talking about serious topics like Exploding Kittens and which Kardashian makes the best linkbait for a tax article.

Not Pictured: SNOWLAB. I'll get one next time.

Not Pictured: SNOWLAB. I’ll get one next time.

Something like Roth IRA Contributions Limits should be super simple. Set a dollar amount (say, $5,500) indexed for inflation, and then don’t allow anyone to contribute over that amount.

The government almost got this one right. They have the $5,500 limit for 2016, indexed for inflation (so we might get up to $5,600 by SMOD‘s inauguration). They even allow a nice extra $1,000 if you’re at least 50 years old.

But, since this is Congress, they went and screwed things up.

(Side note: your Roth IRA Contribution Limits combine with your Traditional IRA contributions. So that $5,500 is both your Roth and Traditional limits combined)

In addition to creating a contribution limitation, they also added an income limitation. This is what my ice cream eating neighbor was complaining about: he made too much money to contribute to a Roth IRA.

That Roth IRA limitation is a bit more convoluted. The rule is that you’re limited based on your AGI (adjusted gross income, or Line 37 on your 1040) exceeding the applicable dollar amount.

To inundate you a little more before clarifying with examples, your Roth IRA Contribution can’t exceed your contribution limit of $5,500 (or 100% of your compensation if you make less than that), reduced by the contribution limit multiplied by the ratio of your AGI less the applicable dollar amount over $15,000 (or $10,000 if you’re married).

And my eyes are glazed over. Let’s stick in a table here for your applicable dollar amounts in 2016:

Filing Status Applicable Dollar Amount Full Phaseout
Married Filing Jointly $184,000 $194,000
Any taxpayer not otherwise listed on this chart $117,000 $132,000
Married Filing Separately $0 $10,000

Alright, does that make you ready to throw your hands up in exasperation and give your information over to the nearest tax professional? Yes? Good. That’s exactly how we intended it. Mwah ha ha.

Wait, no, that’s not right. It’s because a bunch of lawyer politicians were trying to be too clever for their own good.

Let me throw down some examples to help out.

Example #1: You’re a married dude or dudette under 50 filing jointly with your spouse. You make less than $184,000. You can take up to the full Roth IRA Contribution amount for the year, no complex calculations necessary.

Example #2: You’re still married and under 50, but now you make 194,000. You’re out of luck. No Roth IRA for you.

Example #3: Still married, still under 50, but now making 190,000. You’re in The Bad Land. Take your contribution limit of $5,500, and multiply it by the difference between that and your dollar limitation, divided by $10,000. So $5,500 x (190,000 – 184,000)/10,000 = $3,300 is your Roth IRA Contribution Limit.

How many people are going to happen to fall right in this narrow strip? Probably not that many, which I’m sure is the government’s rationalization of adding in a complicated calculation to what should be a simple limitation.

The real question is why we needed an AGI limitation of all. Do we really care that much if Kim Kardashian can contribute $5,500 to an IRA? I’m guessing she doesn’t.

For the rest of us in the nose bleed section of economic fortunes, it just creates another worry. Do most people hit that limit? No, but they’re going to read on some scaremongering tax blog that there is a limit, and ten years down the road they’re going to worry if they’ll be able to contribute to a Roth IRA and hire a tax accountant instead of dealing with even more crap.

What makes this all even more pointless is that there’s a “backdoor” to get around this IRA limitation, which makes the limitation another case of politicians wanting to pretend they’re doing something when in fact they’re just making everyone’s life more complicated.

As for how to use that Roth IRA backdoor, stay tuned for my next post (which, at my current posting rate, will be in December).