I had been dutifully contributing to a Roth IRA for years until last year, when I finally made too much money to contribute to it any more. Now, I’m not complaining about this since it’s frankly about the best problem you can have, but I am curious as to what exactly the purpose of the income limitation actually is. If you’re making a very high income then you’re probably paying a higher tax rate, and in any event you’re limited to a $5,500 contribution, which means that for super rich individuals a Roth IRA is probably not all that attractive anyway. The best I can figure is that there’d be some gimmick a high earner might be able to pull to make the Roth work in some unintended way, but I don’t really know what that might be. Can anyone enlighten me?
I looked around when I was trying to figure out my best investment options. Best reason I could find is that Roth IRAs are not for rich people. In any event, if you still want to contribute to a Roth IRA, look up “Back-Door Roth IRAs”
The idea is if you’re earning a lot of money, then you don’t need help (i.e. the tax advantage of an IRA) saving for retirement; beyond a certain income threshold you should, in theory, have enough after-tax income to save and invest in non-IRA investments and still end up with enough to retire comfortably.
Withdrawals from Roth IRAs are untaxed. If there were no contribution limit, people who currently invest outside of IRAs could do that investing in a Roth IRA instead and avoid paying capital gains taxes. That’s probably a not-insignificant amount of revenue for the federal government that would have to made up some other way.
I could understand this argument as applied to traditional IRAs, but there are no income limitations on contributing to those. I understand that this is the basis for the contribution limit applicable to all IRA types (to prevent high earners from stuffing millions of dollars into them), but I still don’t see why you’re limited from contributing to a Roth IRA once your income goes over a certain threshold.
With a traditional IRA all the money you take out is taxed, that means the original untaxed income and all the capital gains and interest. With a Roth IRA, you put in after tax money, but withdrawals are untaxed. That means only the original $$ is taxed; all capital gains and interest is not taxed.
Only people who are of relatively modest means need the government encouraging them to save for retirement. Once you reach a certain income level, there’s no sense in encouraging people to save for retirement more, and you’re simply allowing rich people to accumulate more wealth at taxpayers’ expense. Yes, it’s not a particularly large amount to shield from taxes compared to income at that point, but it’s something. There are tons of tax advantages for the middle class that get phased out as your income goes up, simply because you don’t need the government’s help anymore. Child Tax Credit, Education credits, Student Loan interest deduction, and even personal exemptions are other things that people no longer get once their income gets high enough.
OP is asking about income limits, not contribution limits.
The Roth IRA limit is something like $184k, so we are talking about the top 5% of households, and top 2% of individuals (more or less).
Still, I imagine that adds up; if you’re paying taxes on all those things and making $184k, you may well be better off making say… 175k and getting those deductions.
Probably a little less if the percentages are gross income, because limit is $184k MAGI, but I doubt it changes the numbers much. And of course that’s just where phaseout starts. It’s no contributions after $194k.
$117k and $132k, for individuals.
There is a nice table here.
I get that, but the point is that you make contributions to a Roth IRA with money you’ve already paid taxes on at whatever your current rate is. If you’re in a high bracket, and you anticipate that you will be in a lower bracket when you retire, then a traditional IRA is better for you anyway (because with a traditional IRA you can pay the lower taxes on your withdrawals and get the tax advantage while you’re in the higher bracket.) So I can see the basis for an income limit on traditional IRA contributions, but there isn’t one - anyone can contribute to a traditional IRA regardless of how much money they make, but the Roth IRA, the one that’s not as attractive to high earners anyway, is the one that gets capped. I am trying to understand why that might be, and I’m worried that I didn’t express the question very well.
The short answer would be - Because Congress said so. Congress created both the IRA and the Roth IRA as exemptions to the standard earned income and capital gains tax rules. The Roth came later so it could be considered an improvement over the standard IRA, or as just a 2nd option for the tax-paying income earner. To participate in either plan, you must abide by the existing rules of that plan, no matter how arbitrary those rules many appear to be.
Personally, I wonder why Congress made the effort to create the Roth IRA when Congress could have altered/changed/expanded/improved the existing IRA rules. But that’s Congress, for ya.
You ask why there is a limit? For that information you, or a kind stranger, would need to peruse the Congressional Record for the relevant statements made by our elected representatives during the 105th Congress. After you’ve waded thru the yada, yada, yada, and blah, blah, blah, one, or more, of our elected representatives may actually explain their reasoning.
*The Taxpayer Relief Act of 1997 (Pub.L. 105–34, H.R. 2014, 111 Stat. 787, enacted August 5, 1997) reduced several federal taxes in the United States.
Roth IRAs were established, permanently exempting these retirement accounts from capital gains taxes.*
Pub.L. 105–34
*SEC. 302. ESTABLISHMENT OF NONDEDUCTIBLE TAX-FREE INDIVIDUAL RETIREMENT
ACCOUNTS.
(a) In General.--Subpart A of part I of subchapter D of chapter 1
(relating to pension, profit-sharing, stock bonus plans, etc.) is
amended by inserting after section 408 the following new section:
``SEC. 408A. ROTH IRAS.
``(a) General Rule.--Except as provided in this section, a Roth IRA
shall be treated for purposes of this title in the same manner as an
individual retirement plan.
``(b) Roth IRA.–For purposes of this title, the term `Roth IRA’
means an individual retirement plan (as defined in section 7701(a)(37))
which is designated (in such manner as the Secretary may prescribe) at
the time of establishment of the plan as a Roth IRA. Such designation
shall be made in such manner as the Secretary may prescribe.*
https://www.gpo.gov/fdsys/pkg/PLAW-105publ34/html/PLAW-105publ34.htm
If you have a retirement plan through your work, the deduction phases out lower than that anyway.
No - bump was talking about the Roth IRA and the Roth limit is independent of having a retirement plan at work. The traditional IRA income limits depend on whether you have a work plan.
That’s the entire answer. Several posts have focused on contribution limits, but that wasn’t the question. Other posts a little closer to point have said eg ‘better off people don’t need a tax break on retirement contributions’. But that ignores the fact that traditional IRA’s (and other tax deferred savings vehicles like 401k’s, either company or individual for the self-employed) don’t have income limits, and are available to taxpayers of any income. It also ignores the point one post referred to indirectly, the back door Roth*, which largely negates the Roth income limit if you’re willing to jump through a couple of minor hoops.
There is no consistent logic to it overall. It’s just what was needed for a majority of Congress to agree at the time the legislation was passed.
*there is no income limit on converting a traditional IRA to a Roth. So if you’re above the income limit to make Roth contributions, you can make traditional IRA contributions (deductible or non-deductible depending on your situation) and periodically convert the account to a Roth, at that time recognizing taxable income on the contributions and gains (in case of deductible traditional IRA contributions) or just the gains (in case of non-deductible traditional IRA contributions).
I believe he was comparing Roth IRA vs Traditional (deductible). I base this on the fact that he was talking about deductions, and Roth IRAs aren’t deductible.
If you make close to the Roth IRA income limit, it may indeed make more sense to use a traditional IRA and deduct the contributions. Except that many people cannot do so.
Right. So if you can’t deduct the IRA contributions, it’s better to use a Roth IRA, since at least the earnings won’t be taxed.
But the income limit he mentioned was that for the Roth.
Yes, and he said that if you were near that income limit, it might be better to not use a Roth, and instead deduct.
So I pointed out that it’s not an option for some people.
I know if you make a nondeductible Traditional IRA contribution, you don’t pay tax on that amount when you take it out on retirement. However, you do pay taxes on the gains.
To really answer the OP’s question, I think when politicians get involved in a process like this, they do grand-standing about why they are supporting something, when in reality it has little to do with an actual benefit to all or is even fair. Like taxes being based on if someone is single or married sounds like the government is trying to encourage people to get married.
If someone for whatever reason wanted to contribute money so they didn’t have to pay taxes on it when they retire, they should have the option to make those contributions to do that with a Roth IRA regardless of income. But then the government wouldn’t be able to collect taxes like they do with Traditional IRA required minimum distributions.