Traditional IRA versus Roth IRA – 2011 Contribution and Phase-out Income Limits

[Updated Nov 2010] The IRS has released the official 2011 401K and IRA Limits. These have been updated based on 2011 cost of living adjustments (COLA) which remained unchanged again this year. The main impact to IRA and Roth IRA plans are the income eligibility/phase-out limits. The table below summarizes the key rules and limits around 2011 Traditional IRA and Roth IRA retirement plans:

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- The deduction for taxpayers making contributions to a traditional IRA is phased out for singles and heads of household who are active participants in an employer-sponsored retirement plan and have modified adjusted gross incomes (AGI) between $56,000 and $66,000, unchanged from 2010.

For married couples filing jointly, in which the spouse who makes the IRA contribution is an active participant in an employer-sponsored retirement plan, the income phase-out range is $90,000 to $110,000, up from $89,000 to $109,000. For an IRA contributor who is not an active participant in an employer-sponsored retirement plan and is married to someone who is an active participant, the deduction is phased out if the couple’s income is between $169,000 and $179,000, up from $167,000 and $177,000.

The AGI phase-out range for taxpayers making contributions to a Roth IRA is $169,000 to 179,000 for married couples filing jointly, up from $167,000 to $177,000 in 2010. For singles and heads of household, the income phase-out range is $107,000 to $122,000, up from $105,000 to $120,000. For a married individual filing a separate return who is an active participant in an employer-sponsored retirement plan, the phase-out range remains $0 to $10,000.

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[Previous update - 2010 IRA and Roth IRA Income and Contribution limits] Received a couple of reader questions over the last month asking me to clarify the difference between a Roth IRA and Traditional IRA plan. Both are excellent retirement investment vehicles, but based on your income and tax situation one may be a better first choice than the other. Here are some key differences and a summary table of the two retirement investment options for easy reference.

Traditional IRA

A Traditional IRA offers a tax-deferred retirement investment option, with investors being able to deduct all or part of their contributions from pretax income if certain conditions are met. This also makes it an effective way to reduce current tax obligations – particularly for those in higher income tax brackets.

There are no income limitations on being able to contribute to a Traditional IRA, but you must be under age 70½ and have earned income. You must also have earned income equal to or greater than your contributions.

In 2010, the maximum contribution to a traditional IRA is $5,000, with an additional $1,000 (total of $6,000) if you are age 50 or older.

You generally pay taxes when you make withdrawals, at which time you may be in a lower tax bracket. If you withdraw before the official retirement age (59 ½), you will also have to pay additional penalties unless you can prove extenuating circumstances (like spouse death, hardship, disability and qualified medical expenses).

All withdrawals from a Traditional IRA (except for amounts attributable to nondeductible contributions) are generally taxed as ordinary income – a key difference to Roth IRA’s. You must begin taking required minimum distributions by April 1 of the year following the year in which you reach age 70½.

You’re eligible for a fully deductible IRA contribution if neither you nor your spouse participates in an employer-sponsored (401K) retirement plan. If either of you do participate in such a plan, your ability to deduct your full IRA contribution may be limited by your income. Generally if you earn more than $66,000 (Single) or $109,000 (married) and contribute to a 401K, 403b or other employer sponsored plan your contributions to a Traditional IRA plan are not tax deductible.

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Roth IRA

A Roth IRA, like a traditional IRA, is a tax effective/differed retirement savings plan. Unlike the traditional IRA though, once you reach age 59½, you may qualify for tax-free withdrawals of both contributions and any accumulated earnings. In addition, you’re never required to take distributions, making a Roth IRA an effective option for both retirement and estate planning purposes.

Further, you may realize tax savings if you think your tax bracket in retirement will be higher than your current rate. A five-year holding period required for tax-free withdrawals regardless of investor’s age.The Roth IRA is subject to penalties if withdrawn early, but up to $10,000 in earnings may be withdrawn tax-free if used for a qualified first-time home purchase.

The Roth IRA is also an effective inheritance vehicle because you may potentially reduce or eliminate the taxes your beneficiaries will have to pay after inheriting.

You may be able to contribute to a Roth IRA for yourself or your spouse if you have earned income. You must also fall below the following income limits

For married filing jointly—$177,000 modified adjusted gross income for tax year 2010 (vs. $176,000 for tax year 2009)
For single taxpayers—$120,000 modified adjusted gross income for tax year 2009 and 2010 or married filing separately

See this article for more details on 2010-2011 Roth IRA limits

2010 Combined Traditional and Roth IRA Contribution Limits

You can contribute to both a Traditional and Roth IRA Plan, but must be aware of the following limits as mandated by the IRS

If you are under 50 years of age at the end of 2010: The maximum contribution that you can make to a traditional or Roth IRA is the smaller of $5,000 or the amount of your taxable compensation for 2010. This limit can be split between a traditional and a Roth IRA but the combined limit is $5,000. The maximum contribution to a Roth IRA and the maximum deductible contribution to a traditional IRA may be reduced depending upon your modified adjusted gross income (modified AGI).

If you are 50 years of age or older before 2011: The maximum contribution that can be made to a traditional or Roth IRA is the smaller of $6,000 or the amount of your taxable compensation for 2010. This limit can be split between a traditional and a Roth IRA but the combined limit is $6,000. The maximum contribution to a Roth IRA and the maximum deductible contribution to a traditional IRA may be reduced depending upon your modified AGI.

This limit can be split between a traditional and a Roth IRA but the combined maximum limit is still $5,000 (or $6,000 for those 50 and older)

(Reference sources: T. Rowe Price)