Most of us do not give it another thought and simply assume we can contribute to an IRA if we meet IRS income criteria. But what if your only source of income is alimony? Guess what – the new tax law changes may just eliminate your only means to save in a retirement account.
An individual retirement arrangement (IRA) is a tax-favored personal savings arrangement, which allows you to set aside money for retirement. There are several different types of IRAs, including traditional IRAs and Roth IRAs. You can set up an IRA with a bank, insurance company, or other financial institution.
- To make a contribution to either a traditional or Roth IRA, you have to have what the IRS defines as “earned income.”
- The one exception is a spousal IRA for a non-working spouse.
- If you don’t qualify for an IRA but have other sources of income, you should still make saving for retirement a priority.
What’s considered compensation
You don’t have to work for someone else to have taxable compensation. You can also work for yourself. Compensation from either type of employment would be considered earned income.
Compensation for purposes of an IRA contribution includes:
- Wages, salaries, tips, etc.
- Commissions, professional fees
- Self-employment income
- Alimony* and separate maintenance
- Nontaxable combat pay
* Under the Tax Cut and Jobs Act, this may change in 2019.
In terms of an IRA contribution, the amount of your earned income is also important. The maximum contribution you can make for 2018 is $5,500 ($6,500 if you’re 50 or older). But if your taxable income is less than the maximum contribution, you can only contribute up to the actual dollar amount of your earned income for the year. In other words, you can’t contribute more to your IRA than you earn.
What about if you receive alimony in 2019 that is nontaxable?
Alimony aka spousal support will no longer be considered compensation or earned income and therefore you will not be able to contribute to an IRA. This presents an enormous challenge for ex-spouses who do not work and thus cannot save monies in a tax deferred account for retirement. This situation may change before 2019 but as it stands now, if one
What about unearned income?
Of course, there are other ways to make money, so it’s also important to understand what’s not considered to be earned income. Things such as interest and dividends from investments, pensions, Social Security benefits, unemployment benefits, and child support—even though they may factor significantly in your monthly bottom line—aren’t considered earned income for tax and IRA contribution purposes.
Compensation for purposes of an IRA contribution does not include:
- Earnings and profits from property like rental income, royalties
- Interest and dividend income
- Pensions or annuity income
- Unemployment income
- Social Security
- Income from certain partnerships
- Any amounts you exclude from income