Make sure you aren't overlooking some strategies and potential tax benefits.
- IRAs are available to nonworking spouses.
- IRAs allow a "catch-up" contribution of $1,000 for those 50 and up.
- IRAs can be established on behalf of minors with earned income.
It's the time of year when IRA contributions are on many people's minds—especially those doing their tax returns and looking for a deduction. Due to the impact of COVID-19, the new date for filing federal income tax returns and for making contributions to your IRA for 2019 is July 15, 2020. Chances are, there may be a few things you don't know about IRAs. Here are 7 commonly overlooked facts about IRAs.
1. A non-working spouse can open and contribute to an IRA
A non-wage-earning spouse can save for retirement too. Provided the other spouse is working and the couple files a joint federal income tax return, the nonworking spouse can open and contribute to their own traditional or Roth IRA. A nonworking spouse can contribute as much to a spousal IRA as the wage earner in the family. For 2019 and 2020, the limit is $6,000, or $7,000 if you're over 50. The amount of your combined contributions can't be more than the taxable compensation reported on your joint return.
2. Even if you don't qualify for tax-deductible contributions, you can have an IRA
If you're covered by a retirement savings plan at work—like a 401(k) or 403(b)—and your 2019 modified adjusted gross income (MAGI) exceeds applicable income limits, your contribution to a traditional IRA might not be tax-deductible. But getting a current-year tax deduction isn't the only benefit of having an IRA. Non-deductible IRA contributions still offer the potential for your money and earnings to grow tax-free until the time of withdrawal. You also have the option of converting those non-deductible contributions to a Roth IRA (see No. 7, below).
3. Beginning in 2019, alimony will not count as earned income to the recipient
Unless the new tax rule changes, you will likely not be able to use money received as alimony to fund an IRA beginning in tax year 2019. That's due to changes in the law introduced by the Tax Cuts and Jobs Act of 2017: Alimony payments from agreements entered into January 1, 2019 or after, are no longer considered taxable income to the recipient—and the source of IRA contributions must be taxable earned income. Alimony agreements entered into prior to December 31, 2018 are grandfathered in; they are tax-deductible for the person making the payments, and count as income to the recipient. It is the date of the agreement that decides the taxation of the alimony payment; not the year of receipt of the funds.
4. Self-employed, freelancer, 1099'er? Save even more with a SEP IRA
If you are self-employed or have income from freelancing, you can open a Simplified Employee Pension plan—more commonly known as a SEP IRA. Even if you have a full-time job as an employee, if you earn money freelancing or running a small business on the side, you could take advantage of the potential tax benefits of a SEP IRA. The SEP IRA is similar to a traditional IRA where contributions may be tax-deductible—but the SEP IRA has a much higher contribution limit.
The amount you, as the employer, can put in varies based on your earned income. For SEP IRAs, you can contribute up to 25% of any employee's eligible compensation up to a $56,000 limit for 2019 contributions and $57,000 for 2020. Self-employed people can contribute up to 20% of eligible compensation to their own account. The deadline to set up the account is the tax deadline. But, if you get an extension for filing your tax return, you have until the end of the extension period to set up the account or deposit contributions. Due to the impact of COVID-19, the new date for filing federal income tax returns and for making contributions to your IRA for 2019 is July 15, 2020.
5. "Catch-up" contributions can help those age 50 or older save more
If you're age 50 or older, you can save an additional $1,000 in a traditional or Roth IRA each year. This is a great way to make up for any lost savings periods and make sure that you are saving the maximum amount allowable for retirement. For example, if you turn 50 this year and put an extra $1,000 into your IRA for the next 20 years, and it earns an average return of 7% a year, you could have almost $44,000 more in your account than someone who didn't take advantage of the catch-up contribution.
6. You can open a Roth IRA for a child who has taxable earned income
Helping a young person fund an IRA—especially a Roth IRA—can be a great way to give them a head start on saving for retirement. That's because the longer the timeline, the greater the benefit of tax-free earnings. Although it might be nearly impossible to persuade a teenager with income from mowing lawns or babysitting to put part of it in a retirement account, gifting money to cover the contribution to a child or grandchild can be the answer—that way they can keep all of their earnings and still have something to save. The contribution can't exceed the amount the child actually earns, and even if you hit the maximum annual contribution amount of $6,000 (for 2019 and 2020), that's still well below the annual gift tax exemption ($15,000 per person in 2019 and 2020 or with gift splitting, a married couple could gift their child $30,000 a year.)
A Roth IRA for Kids, specifically for minors, is a custodial IRA. This type of account is managed by an adult until the child reaches the appropriate age for the account to be transferred into a regular Roth IRA in their name. This age varies by state. Funds in the custodial IRA do not count toward assets when considering Expected Family Contributions for college. Bear in mind that once the account has been transferred, the account's new owner would be able to withdraw assets from it whenever they wished, so be sure to educate your child about the benefits of allowing it to grow over time and about the rules that govern Roth IRAs.
7. Even if you exceed income limits, you may be able to have a Roth IRA
Roth IRAs can be a great way to achieve tax diversification in retirement. Distributions of contributions are available anytime without tax or penalty, all qualified withdrawals are tax-free, and you don't have to start taking required minimum distributions at age 72. But some taxpayers make the mistake of thinking that a Roth IRA isn't available to them if they exceed the income limits. In reality, you can still establish a Roth IRA by converting a traditional IRA, regardless of your income level.
If you don't have a traditional IRA you're still not out of luck. It's possible to open a traditional IRA and make non-deductible contributions, which aren't restricted by income, then convert those assets to a Roth IRA. If you have no other traditional IRA assets, the only tax you'll owe is on the account earnings—if any—between the time of the contribution and the conversion.
However, if you do have any other IRAs, you'll need to pay close attention to the tax consequences. That's because of an IRS rule that calculates your tax liability based on all your traditional IRA assets, not just the after-tax contributions in a nondeductible IRA that you set up specifically to convert to a Roth. For simplicity, just think of all IRAs in your name (other than inherited IRAs) as being a single account.