Not me but a coworker. She is married but they file separately for student loan purposes and they do live together (that’s important). Since she makes more than $10,000 / yr she is not allowed to contribute anything to a Roth IRA. I understand if the rules were modified so that people couldn’t game the system but as it is if they filed jointly they could make full contributions so can anyone explain the reason for this IRS rule to me in a way that makes sense?
There is an effort to limit IRAs overall, with the belief that the "rich’ (upper middle class and above) who could afford to pay taxes use IRAs/401ks. But the working poor don’t have the discretionary cash to do that and don’t utilize this benefit.
So it doesn’t help those that it should and hoses the government in the process.
They could also both make Roth IRA contributions if they didn’t live together. The purpose of the rule is to disincentivize people from gaming the system. They are filing separately to get big benefits to pay off their student loans - the payoff is they don’t get the benefits of Roth contributions.
How is it gaming the system if combined they make less than the limit if married.
There is a reason they are filing married/separate instead of married/jointly. The OP said it was “for student loan purposes”, which likely means that the wife is on a means-based loan forgiveness program or other reduced payment system. They’ve also likely done the math that doing their taxes that way is a greater benefit to them than being able to contribute to a Roth IRA.
I don’t mean to imply that “gaming the system” is a bad thing - they’re just doing what benefits them the most in a system seemingly designed for confusion.
So basically, “You are married filing separate to get some benefit somewhere with somebody. Therefore we are taking away your Roth IRA benefit.”?
Exactly.
Since I guess the OP has been answered, are they eligible to do a backdoor contribution (Non-deductible Trad-IRA immediately rolled into a Roth)?
That might be advisable as long as they don’t have any Traditional IRA basis from previous year’s contributions. Assuming their goal is to get money into a Roth for future tax purposes.
Yes - a back door would be allowed as there are no income restrictions on them. They could also contribute to a 401k Roth.
[Moderating]
This is not a factual answer to this question, and so is not appropriate for the FQ forum, especially not as the first response.
I don’t know about the REASON for the rule, but the limits are something like 153K if single, and 228K if married filing jointly.
I had thought that you mistyped her income (10,000 a year) but I googled it, and it really IS that restrictive if married filing separately. I guess her husband also falls into that boat.
I’m not all that familiar with backdoor Roth conversion - I gather you have to convert all or nothing from an IRA, but what if there are multiple accounts? Can you convert all of one account, and leave the other(s) in place? (answering my own question: it can be done, though there are some weird pro-rata rules that don’t entirely make sense to me).
Any chance her workplace has a Roth option on their 401(k)? If so, she can contribute to that regardless of her income. Both my job and my husband’s have that option; we are both putting money in both buckets (pretax and Roth). (edited: I see Munch also mentioned a Roth 401(k).
Thanks for doing the research. I also wondered at the $10,000 limit as it seemed too low.
You can convert any portion of an IRA to a Roth - many limit the amount to avoid a higher tax bracket.
OK. Didn’t think it was that out of line, as there is not a factual answer.
So is the logic that if one spouse makes a lot of money, they don’t want the other lower paid spouse to benefit from large contributions (and drastically reduce their taxes) with contributions that obviously come from the higher-income spouse, unless they either file jointly or the second spouse is effectively not full-time employed? (I note that for a spouse with $10,000 income limit, there is effecively no tax deduction?) Basically if you file separately then you can’t use the other spouse’s cash to fluff up your savings and reduce taxes, but the only practical way for the IRS to enforce it is to say “no contributions at all”.
otherwise, it’s a crude form of income splitting, which runs counter to the concept of filing separately.
No, this is for Roth IRAs, so there is no upfront tax benefit, because contributions to a Roth have already paid taxes on the amount. Note that if the lower-paid spouse actually earns less than $10,000 can contribute to a Roth, and does so essentially tax free (since income at that level isn’t taxed federally).
As another poster noted, there’s no deduction in this case as we’re talking about a Roth contribution.
Decades ago (long before Roth IRAs were a thing), they had just started tightening down on who could make a deductible contribution. My husband and I filed separately one year, as it meant HE could make a deductible contribution to his IRA while I could not. Jointly, our income was high enough that neither of us could deduct it.
The following year, neither of us could; they had closed the “file separately” loophole.