Are Roth IRA phaseouts really that bad for those phased out?
May 13th, 2007 | by mbhunter |If you're new here, you may want to subscribe to my RSS feed. Thanks for visiting!
Jim threw this out to his readers:
Roth IRA Phaseout Makes No Sense
The phaseout rule that Jim is wondering about is the eligibility to contribute to a Roth IRA when one’s adjusted gross income is too high. If your AGI is $110k or more ($160k or more, if married filing jointly) then you’re ineligible to contribute to a Roth IRA — a retirement vehicle that allows tax-free compounding and tax-free withdrawal under certain rules.
Although it was mentioned that high wage earners are more likely to take advantage of the Roth IRA since they (presumably) have more disposable income to dedicate to retirement savings, and hence the architects of this retirement vehicle were controlling its costs by making ineligible many who were most likely to contribute to it, it goes a little further. Not only are the high wage earners more likely to contribute, they’re also likely to save more in taxes upon withdrawal for the same contribution because they’ll likely be in a higher marginal tax bracket when they do withdraw. Not collecting tax at 35% costs the government a lot more than not collecting tax at 15%.
If one doesn’t qualify for Roth IRA contributions, I can’t really feel too sorry, though. Big earners that can’t qualify for Roths are more likely to be accredited investors who can qualify for investment vehicles that the rest of us can’t. They don’t need to invest in Roths; they have access to some of the best investments out there, safely tucked away from the rest of our money and thus from being bid up in price.
You have to earn more than $200k per year to be an accredited investor. The standard reasoning is to “save the unsophisticated investor from himself or herself” by setting a wealth floor and by carefully regulating the goings-on of the vehicles of investments that we can get into, protecting us from chicanery. So here are two questions: Why does earning $200k or more per year make one a sophisticated investor? (Answer: It doesn’t.) And why does earning less than $200k per year make me incapable of evaluating an investment, thereby making me an unsophisticated investor? (Answer: It doesn’t.) Then why the income floor? So the rich can get richer. By only allowing accredited investors into certain investment vehicles, there are a limited number of people buying into them, and the good ones are kept from being bid up too much.
So here’s the takeaway: Aim to earn enough so that you can’t contribute to your Roth IRA, and get into something really good! 
3 Responses to “Are Roth IRA phaseouts really that bad for those phased out?”
By samerwriter on May 13, 2007 | Reply
“they’re also saving more in taxes for the same contribution because they’re in a higher marginal tax bracket.”
I’m confused by this statement; a contribution to a Roth IRA is not tax deductible. True, the earnings are tax free, but there is no savings on the initial contribution.
I think there’s a misconception about high income earners, that somehow they’re given special opportunities because of their income.
The difference between making $199,000 and $200,000 is about $500 after taxes. When you hit this income, you don’t start getting special offers in the mail for higher-yielding money market accounts or better mutual funds.
By dimes on May 13, 2007 | Reply
Meh, I’m just amazed to see that most of the people I see who have hit the phaseout limits for Roths are not contributing to ANY sort of retirement account, be it a traditional IRA, a TSP or a 401k/403b. What do they plan to do when they turn 70? Keep working?
By mbhunter on May 13, 2007 | Reply
Samerwriter, you’re right that the way I phrased it wasn’t quite clear (or correct).
You’re also correct that the contributions are not tax-free. I meant to imply that the tax savings at withdrawal would be larger if one was in a higher marginal tax bracket. Thanks for helping me to clarify this!