One frequently overlooked tax benefit is the spousal IRA. Generally, IRA contributions are only allowed for taxpayers who have compensation (i.e. wages, tips, bonuses, professional fees, commissions, taxable alimony received, and net income from self-employment). Spousal IRAs are the exception to that rule and allow a non-working or low-earning spouse to contribute to his or her own IRA, otherwise known as a spousal IRA, as long as the spouse has adequate compensation.
The maximum amount that a non-working or low-earning spouse can contribute is the same as the limit for a working spouse, which is $6,000 for 2020 and 2021. If the non-working spouse’s age is 50 or older, that spouse can also make “catch-up” contributions (limited to $1,000), raising the overall contribution limit to $7,000. These limits apply provided that together the couple has compensation equal to or greater than their combined IRA contributions.
Consider this example: Tony is employed and his W-2 for 2020 is $100,000. His wife, Rosa, age 45, has a small income from a part-time job totaling $900. Since her own compensation is less than the contribution limit for the year, she can base her contribution on their combined compensation of $100,900. Thus, Rosa can contribute up to $6,000 to an IRA for 2020.
The contributions for both spouses can be made either to a traditional or Roth IRA, or it can be split between them as long as the combined contributions don’t exceed the annual contribution limit. However, please be cautious that the deductibility of the traditional IRA and the ability to make a Roth IRA contribution are generally based on the taxpayer’s income:
- Traditional IRAs: There is no income limit restricting contributions to a traditional IRA. However, if the working spouse is an active participant in any other qualified retirement plan, a tax-deductible contribution can be made to the IRA of the non-participant spouse only if the couple’s adjusted gross income (AGI) doesn’t exceed $198,000 in 2021 ($196,000 for a married couple in 2020).
- Roth IRAs: Roth IRA contributions are never tax deductible. Contributions to Roth IRAs are allowed in full if the couple’s AGI doesn’t exceed $198,000 in 2021 ($196,000 for a married couple in 2020). The contribution is ratably phased out for AGIs between $198,000 and $208,000 in 2021 ($196,000 and $206,000 in 2020). Thus, no contribution is allowed to a Roth IRA once the 2021 AGI exceeds $208,000.
Consider this example: Rosa can designate her 2020 IRA contribution as either a deductible traditional IRA or a nondeductible Roth IRA because the couple’s AGI is under $196,000. Had the couple’s AGI been 201,000, Rosa’s allowable contribution to a deductible traditional or Roth IRA would have been limited to $3,000 because of the phase-out. The other $3,000 could have been contributed to a traditional IRA and designated as nondeductible.
If you would like to discuss spousal IRAs or need assistance with your retirement planning, please contact Cray Kaiser today.
Please note that this blog is based on tax laws effective in December 2020, and may not contain later amendments. Please contact Cray Kaiser for most recent information.