IRA Phase Outs (aka when you make too much money for IRAs)

A lot of us millennials are familiar with putting money into a Traditional or Roth IRA for retirement savings.  When we first started working, contributing the max amount ($5,500 for 2014) into an IRA was nearly impossible for us and our entry-level salaries.  But as we work our way up the corporate ladder, we will start to experience “rich people problems” such as making too much money for IRAs.  Let me explain…

First, you have your Traditional IRAs.  For someone who is single (for tax purposes), the phase-out for 2014 begins at $60,000 and ends at $70,000.  What this means is that if your Adjusted Gross Income in 2014 is $60,000 or less, you can deduct the full amount you put into your Traditional IRA (on line 32).  If your AGI is $70,000 or more, you can’t deduct anything that you put into your Traditional IRA.  And if your AGI is somewhere between $60k-$70k, you can deduct part of the amount you put into your Traditional IRA.  Fidelity has a simple calculator that you can use to see how much of a deduction you can take.  Click “yes” under the Employer-Sponsored Plan section if you have a 401k with your employer.

Next, you have your Roth IRAs.  For a single person in 2014, the phase-out begins at $114,000 and ends at $129,000.  The reason why the phase-out limit is so much higher for Roth IRAs than Traditional IRAs is because with Roth IRAs, you do not get an immediate tax deduction regardless.  That’s just not how Roth IRAs work.  So the phase-out is for whether or not you can even contribute to the account and if so, how much.  If your AGI is $114k or less, you can contribute up to the max ($5,500 for 2014).  If it’s $129,000 or more, you can’t contribute anything.  If you fall within the phase-out range, you can contribute up to a specific amount.  You can use the calculator provided above to see what that amount is.

And lastly, you have your Non-Deductible IRAs.  There is no phase-out for Non-Deductible IRAs because it works like a Traditional IRA without the immediate tax benefits.  This IRA is appropriate for people who have an AGI over the phase-out limits for both Traditional and Roth IRAs but still want to take advantage of the tax-free growth.  So even though you don’t get to deduct your contribution on your tax return, you still don’t have to pay taxes on your account’s earnings each year.

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4 thoughts on “IRA Phase Outs (aka when you make too much money for IRAs)

  1. Great read – and very helpful. Can you go into detail on the differences between a Non-deductible IRA vs a Roth IRA? Why is a Roth better than a non-deductible IRA? Also does the 5.5k (for 2014) contribution cap apply to Non-deductible IRA?

  2. A Roth IRA has 2 tax benefits – you get tax-free growth on your earnings and when you withdraw the money in retirement, it’s also tax free. With a Non-deductible IRA, you only get 1 tax benefit – tax-free growth on earnings. You will have to pay taxes on the money you withdraw during retirement. More tax benefits is one reason why a Roth is better than a Non-deductible IRA.

    Another reason is because most of us millennials are still in the early stages of our career, which means we’re probably in a lower tax bracket (25% or 28%). The salary we’ll be earning right before retirement will probably bump us into a higher tax-bracket (33%, 35% or 39.6%) and we’ll probably need to withdraw that level income from our retirement accounts during our retirement years to continue the lifestyle we’ve grown accustomed to. This means we will continue to STAY in the higher tax-bracket and if we’re taking money out of a Non-Traditional IRA (or Traditional IRA), we’ll be paying taxes at that higher rate. So for instance, we might end up paying 35% in taxes during retirement instead of the 25% we could just pay now with a Roth.

    Hope that answers your question! If not, feel free to ask for more clarification.

    And yes, the contribution limit ($5,500) applies to Non-deductible IRAs as well!

  3. Hi Annie,

    Informative article by the way. Just a quick question though. You mentioned about the phase-out period for Traditional IRAs and how you can’t apply the full tax deduction if your AGI is between $60,000 – $70,000. Do you know what tax deduction percentage is applied during this phase-out range and is it a fixed percentage (assuming AGI of $60,001 as oppose to $69,999)?

    Best Regards,
    Nguyen

    • Hi Nguyen,

      I don’t know the exact formula for calculating the deductible amount within the phase-out range but I believe you can get the answer you’re looking for using this calculator:

      https://scs.fidelity.com/products/mobile/ira/ira-calc.shtml

      I just played around with it and it looks like you can still deduct the max ($5,500) until you reach an AGI of $60,020. So if your AGI is $60,001, you can still deduct up to $5,500. But once you hit $60,020, you can only deduct $5,490.

      And if you make $69,999, you can only deduct $200.

      Hope that helps!

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