IRA Phaseouts: How Will They Affect My Retirement Savings?

IRAs are a great way to save for retirement and get helpful tax benefits. However, the IRS restricts your ability to use fully the tax breaks that IRAs offer if your modified adjusted gross income for tax purposes is above certain limits.

IRA phaseout provisions apply in such situations to reduce the value of the tax benefits you can get, eventually eliminating them entirely for those with high enough incomes. Yet there are several different phaseout provisions depending on the type of IRA you use, your tax filing status, and whether you have access to a workplace retirement plan, and so it can be hard to understand how phaseouts work and what impact they have on your ability to use IRAs. 

Below, you'll find a simple explanation of IRA phaseouts and how they might affect your retirement savings.

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Income limits when IRA phaseouts begin

The first thing you need to know about phaseouts is the modified adjusted gross income limits at which they take effect. Two sets of phaseout provisions apply to the two types of IRAs.

For Roth IRAs, the MAGI range in which phaseouts apply are as follows:

Data source: IRS.

For traditional IRAs, MAGI limits apply only if you or your spouse has access to a retirement plan at work, such as a 401(k). If you have access to such a plan, then the phaseouts are as follows:

Data source: IRS.

On the other hand, if you don't have access to an employer plan but your spouse does, then these higher limits apply:

Data source: IRS.

What exactly gets phased out?

Another source of confusion about phaseouts is that what you can or can't do differs depending on the type of IRA you use.

With a Roth IRA, the phaseout limits your ability to make contributions at all. If your MAGI is in the phaseout range, then you won't be able to contribute the full $5,500 amount for those under 50, or $6,500 for those 50 or older. The amount of the reduction is proportional to the amount of income above the lower phaseout limit compared to the width of the phaseout range.

Image source: Getty Images.

An example can help clarify. Say you're age 55 and married filing jointly with MAGI of $188,000 in 2016. You want to contribute the maximum possible amount to a Roth. To determine the phaseout impact, take $188,000 and subtract the lower phaseout limit of $184,000 to get $4,000. Next, compare that to the range between the upper and lower ends of the phaseout band, which in this case is $10,000. Because $4,000 divided by $10,000 is 40%, your $6,500 maximum contribution will be reduced by 40%. You'll therefore be able to contribute only $3,900 to a Roth IRA.

For traditional IRAs, the phaseout does not limit your ability to contribute, but it does stop you from deducting the full amount. The same calculation method applies.

Again, let's take a similar situation involving a 55-year-old who is married filing jointly with MAGI of $110,000 in 2016 and has access to a retirement plan at work. To calculate the phaseout, take $110,000 minus the lower limit of $98,000 to get $12,000, and then compare it to the width of the phaseout band, which is $20,000 -- $12,000 divided by $20,000 gives 60%. As a result, the maximum deduction will be reduced by 60%, giving you a maximum deduction of just $2,600.

A couple last things to keep in mind

Note that in the case of traditional IRA phaseouts, nothing stops you from making the full available contribution. You just won't necessarily be able to deduct all of it. In the example above, if you put in anywhere from $2,601 to $6,500, the excess above $2,600 will be treated as a nondeductible IRA contribution.

Also, it's tempting to think that you could contribute to a Roth up to the maximum and then simply use the rest to contribute to a traditional IRA. However, the worksheet allowing a phased-out Roth requires you to reduce the permitted Roth contribution by the amount put into other traditional IRAs.

Phaseout provisions are tricky, and it can be tough to keep all the IRA phaseouts straight. However, knowing how phaseouts work will let you take maximum advantage of IRAs even if you have a high income.