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What is your MAGI and how to lower it is a topic pertinent to how your taxes get calculated among other things. MAGI is relevant to understanding your retirement savings contribution limits and contributing to a 401K and HSA can lower your MAGI. So let’s get into it!

Understanding Modified adjusted gross income (MAGI) requires other details and definitions first which we will cover in this blog post. Remember to verify all numbers and facts yourself. This post is an overview or general guidance to help align your own homework and Google searches on the topic.

Introduction to MAGI

Modified adjusted gross income (MAGI) is a tax term that refers to your adjusted gross income (AGI) minus certain deductions. MAGI is used to determine your eligibility for certain tax credits and deductions, as well as your health insurance premium subsidies under the Affordable Care Act.

Why is MAGI important?

Your MAGI is important because it can impact your tax bill. For example, if you have a high MAGI, you may not be eligible for certain tax credits or deductions. Additionally, your MAGI can affect your health insurance premium subsidies under the Affordable Care Act. For those who want to utilize Roth IRA as a retirement vehicle (highly recommended if you are eligible), MAGI is used to determine your eligibility and contribution limit.

How MAGI affects contribution to Roth IRA

For Roth IRAs, MAGI limits are used to determine if you are eligible to contribute to a Roth IRA and how much you can contribute. For 2023, the MAGI limits are as follows:

• Single filers: $138,000
• Married filing jointly: $218,000
• Head of household: $138,000

Please check the source to verify all numbers: www.irs.gov

Importance of Roth IRA

A Roth IRA is a special individual retirement account (IRA) where you pay taxes on money going into your account, and then all future withdrawals are tax-free.

A Roth IRA is a special type of tax-advantaged individual retirement account to which you can contribute after-tax dollars. The primary benefit of a Roth IRA is that your contributions and the earnings on those contributions can grow tax-free and be withdrawn tax-free after the age of 59½ assuming the account has been open for at least five years. In other words, you pay taxes on money going into your Roth IRA, and then all future withdrawals are tax-free.

Source: https://www.investopedia.com/terms/r/rothira.asp

Roth IRA does not require having a job with benefits like a 401K so you can do this completely independent of employer benefits and let your earned income grow tax-free which is my favorite personal finance strategy.

Personal finance strategy: What I wish I did in graduate school

Blog excerpt to help you understand the power of a Roth IRA:

And remember the point is to contribute to retirement accounts, whatever you have access to, and then invest the money and it will potentially GROW over time, and in the case of the Roth IRA, your earnings grow TAX-FREE which is HUGE.

The Roth IRA contribution limit is much lower – it is only $6500 this year in 2023. For people with lower incomes such as graduate students, this is perfect. If I had started having this sort of account (totally for free) through something like Fidelity on my own regardless of job then I could have been contributing towards retirement money through this vehicle and compounding that money for much longer. Also, the investments in a Roth IRA grow tax-free and if the investments have dividends, those also grow tax-free. This is what Fidelity says about their Roth IRA option:

But I did not know this in grad school, I only learned about this recently, and hence, sharing it here with you as well.

Contribution limit for IRAs (from the IRS website)

For 2023, the total contributions you make each year to all of your traditional IRAs  and Roth IRAs can’t be more than:

• $6,500 ($7,500 if you’re age 50 or older), or
• If less, your taxable compensation for the year

For 2022, 2021, 2020, and 2019, the total contributions you make each year to all of your traditional IRAs  and Roth IRAs can’t be more than:

• $6,000 ($7,000 if you’re age 50 or older), or
• If less, your taxable compensation for the year

The IRA contribution limit does not apply to:

• Rollover contributions
• Qualified reservist repayments

If your MAGI is below the limit, you can contribute the full amount to a Roth IRA. If your MAGI is above the limit, you may still be able to contribute to a Roth IRA, but your contribution amount will be reduced.

For example, if you are a single filer with a MAGI of less than $153,000, you can contribute a reduced amount to a Roth IRA. Please confirm what this reduced amount is yourself but we know it will be less than $6500. Let me know in the comments!

If your MAGI is above the limit and you want to contribute to a Roth IRA, you can use the backdoor Roth IRA strategy. With this strategy, you contribute to a traditional IRA and then convert the traditional IRA to a Roth IRA. However, there are income limits for the backdoor Roth IRA strategy as well.

If you are unsure if you are eligible to contribute to a Roth IRA, consult a tax advisor.

How to lower MAGI

There are a few ways to lower your MAGI. One way is to contribute to a retirement account, such as a 401(k) or traditional IRA. Contributions to these accounts are made with pre-tax dollars, meaning they are not included in your MAGI. Another way to lower your MAGI is to contribute to a health savings account (HSA). HSAs are available to taxpayers who have a high-deductible health insurance plan. Contributions to HSAs are also made with pre-tax dollars, and they are not included in your MAGI.

Contributing to a 401(k)

A 401(k) is a retirement savings account that is offered by employers. Employees can contribute a portion of their paycheck to their 401(k) account, and the contributions are made with pre-tax dollars. This means the contributions are not included in your MAGI, which can lower your tax bill.

To contribute to a 401(k), you must first determine if your employer offers a 401(k) plan. If your employer does offer a 401(k) plan, you will need to complete a 401(k) enrollment form. The form will ask you how much you want to contribute to your 401(k) account each pay period.

The maximum amount you can contribute to your 401(k) account in 2023 is $22,500. If you are age 50 or older, you can contribute an additional $6,500.

If you can, I would max out your 401(k) contribution for the year so your MAGI is reduced by that amount which is pretty huge.

Contributing to a Health Savings Account (HSA)

An HSA is a tax-advantaged medical savings account available to taxpayers who are enrolled in a high-deductible health plan (HDHP). HSAs are funded with pre-tax dollars, which means that they are not subject to federal income tax. HSA funds can be used to pay for qualified medical expenses, such as doctor’s visits, prescription drugs, and hospital stays.

To contribute to an HSA, you must first determine if you are eligible. You are eligible to contribute to an HSA if you are enrolled in a high-deductible health plan (HDHP) and you do not have any other health coverage that is not considered secondary to the HDHP. If you are comfortable with an HDHP, this might be motivation to enroll in one because you know that will also make you eligible for an HSA.

If you are eligible to contribute to an HSA, you can open an account with a financial institution that offers HSAs. The maximum amount you can contribute to your HSA in 2023 is $3,850 if you have self-only coverage or $7,750 if you have family coverage. If you are age 55 or older, you can contribute an additional $1,000.

Triple tax advantages of an HSA

Your HSA contributions are tax-deductible, you can spend your money tax-free, and any growth is tax-free too. This threefold tax advantage makes an HSA unique and definitely worth considering especially if you are OK with an HDHP and can do it! Of course, only you know what is best for you and serves your needs so don’t take my word for it. Do your own research!

Conclusion on MAGI and how to lower it

There are a few ways to lower your MAGI. One way is to contribute to a retirement account, such as a 401(k) or traditional IRA. Contributions to these accounts are made with pre-tax dollars, meaning they are not included in your MAGI. Another way to lower your MAGI is to contribute to a health savings account (HSA). HSAs are available to taxpayers who have a high-deductible health plan.

Good luck and share your comments below!!