You may think this post is only about Roth IRA Income Limitations for 2011. But it’s really about becoming $142,360 richer in 40 years.
Let’s first talk about income limits for Roth IRAs.
Roth IRA Income Limitations for 2011
The income limits for Roth IRAs in 2011 are based off your Modified Adjusted Gross Income. The income limitations for 2011 are:
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What is Modified Adjusted Gross Income?
Your modified adjusted gross income is your AGI, with certain deductions you previously took added back. For a complete explanation, visit Fairmark‘s guide on MAGI.
Example of a Phase-Out
Roth IRAs have phase-out limits. The total you’re allowed to contribute to a Roth IRA is phased-out proportionately to the amount your income is in-between the two limits.
For example, if your MAGI is $114,500 as a single tax-payer, your 50% between the two limits. Therefore, you can contribute $2,500 this year. Or, if your income is $110,000, your income is 80% in-between the two limits, and thus can contribute $4,000.
Why Write an Entire Post on Income Limits for Roth IRAs?
The purpose of writing about Roth IRA income limitations, is for you to realize that the time to start and contribute to a Roth IRA runs out. Every year you fail to contribute the maximum amount to your Roth IRA, is one less chance to protect $5,000 from taxes.
Hopefully, your income will one day rise above the Roth IRA income limitations. Once it does, you can no longer reap the benefits of Roth IRAs.
Here’s an example of the opportunity cost of failing to contribute to a Roth IRA.
Tax-Efficient Tess contributes $5,000 to her Roth IRA at the age of 25. The following year, she reaches the Roth IRA income limits and can no longer contribute. Even though she contributed just $5,000 once, assuming a 10% return, she will have $226,296 in her Roth at the age of 65.
Procrastinator Peyton doesn’t contribute to his Roth IRA at 25, even though he was within the income limitations. The following year, he makes enough to exceed the income limits for Roth IRAs. Therefore, he saves $5,000 in a taxable account. Even though he returns 10% for 40 years, Procrastinator Perry will only accumulates $83,927 (25% marginal tax rate). A difference of $142,360!
{ 5 comments… read them below or add one }
Can you show your math on this? I can’t quite get the numbers to work….
The Roth makes sense:
N=40
i=10
PV= -5000
FV = 226,296
Are you assuming in the taxable account he’s paying short-term gains every year? If he buys and holds (and lets say its a non-dividend paying stock to keep it easy), the math doesn’t make sense.
N=40
i= 10
PV= -5000
FV = 226,296 —> take out 25% taxes and your left with 170,194 (plus, you arguably would have been paying taxes at a lower Cap Gains rate. Still a big difference, but not quite $142,000+
Did I miss something in your storyline?
Thanks.
I used the following calculator – http://www.dinkytown.net/java/RothIRA.html
We’re off because you’re taking 25% out at the end. While this calculator assumes that you pay taxes every year, and that money doesn’t get to compound.
Hi RJ,
I am relatively new to the blog so you may have already mentioned this in a previous post, but any thoughts on how to diversify in a Roth IRA?
I am 26 and now have a little over $10,000 in the IRA. I put all of the first year’s contribution in a Total Stock Market Index fund. Does it make since to do that again this year? I understand you can’t give specific advice but just thoughts on how you diversify your IRA would be great.
Thanks!
Actually got a post on diversification coming up next Monday.
You’re right, it’s hard to get specific. However, some general advice on what I would do if I were in your situation is to diversify beyond just a TMIF. I would want a small % of bonds, based on my risk, and some of my stock in international funds. Probably around 25%.
The power of just a year is amazing when extrapolated over time.