5 Little-Known Rules About IRA Contributions

Key Takeaways

• There are different income limits for traditional and Roth IRA contributions, but almost anyone can contribute to a Roth IRA.
• There is something called a spousal IRA that allows the earning partner in a couple to make contributions on both partners’ behalf or even just the nonearning partner’s behalf.
• When it comes to contributing to a traditional versus Roth IRA, splitting the difference is a perfectly legitimate way to go.

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. We’re in the midst of peak IRA contribution season. Joining me to discuss five little-known rules about IRA contributions is Christine Benz. She is Morningstar’s director of personal finance and retirement planning and the host of The Long View podcast.

Hi, Christine. Thanks for being here.

Christine Benz: Hi, Susan. Great to see you.

Who Can Contribute to an IRA?

Dziubinski: All right. So, all things IRA. Let’s start out with who can contribute. Now, there are different income limits for traditional and Roth IRA contributions, but you say almost anyone can contribute to a Roth IRA. How so?

Benz: There’s this mechanism called the backdoor Roth IRA, which has been a loophole, really, that people could take advantage of since 2010. But the basic idea is that there are these income limits that you’ll see apply to Roth IRA contributions, direct Roth IRA contributions. The backdoor Roth IRA allows people of any income level, as long as you’ve got earned income to cover the contribution amount, you can make a Roth IRA contribution indirectly. So, the idea is that you’re contributing to a traditional, nondeductible IRA. There are no income limits there, so you’re fine putting the money in, and then you’re converting the funds, once you’ve made the contribution, to a Roth. And this nifty little loophole gives people of any income level the opportunity to contribute to a Roth IRA. There are, in many cases, no taxes related to going through this process. To the extent that there might be taxes, they are probably going to be de minimis. There are exceptions, though, if someone has a lot of traditional IRA assets that have never been taxed, which is a point to encourage people to check with a tax advisor. If this describes your situation before you go down this road of making backdoor Roth contributions, just make sure that it makes sense for you given your situation and the possible tax ramifications of making that contribution.

Spousal IRA

Dziubinski: Got it. Now, what about nonearning spouses, Christine? How can they make contributions to IRAs, despite the requirement that you need to have earned income to contribute?

Benz: There is something called a spousal IRA that allows the earning partner in a couple to make contributions on both partners’ behalf or even just the nonearning partner’s behalf. The name of the game is that the earning partner needs to have enough earned income to cover the contribution amounts that are being made for the household. And of course, you’re subject to the individual contribution limits that apply each calendar year. In 2024, it’s $7,000 if you’re under 50, $8,000 if you’re over 50. But this is a really great idea, I think, for couples, where maybe you’ve got one partner who is the main child caregiver in the family but not earning an income. It’s a great way to keep retirement funding going for that person while he or she is out of the paid workforce. It’s also a really neat idea for older workers where you’ve got one, maybe working partner, one nonworking partner, to keep saving on behalf of the nonearning partner. It’s just a really nice strategy to take advantage of. If you’re an older adult and you’re interested in continuing to save for your retirement, you can do so even if one of you is not earning an income.

You often hear from retirees about what to do with RMDs, required minimum distributions, that they don’t need. So, you could be an RMD-subject retiree, but if your spouse is still working and you’ve got extra funds coming from RMDs, you can actually take the money and put it in an IRA. As long as your partner has earned income to cover the contribution, you can get the money working in an IRA. So, it’s something to investigate. It’s kind of a high-class situation to be in, but it’s something to investigate if you’re interested in continuing to earn some tax advantages with your retirement savings.

Traditional IRA vs. Roth IRA Contribution

Dziubinski: Interesting. Now, people often wonder, should I be making a traditional IRA contribution, or should I be making that Roth contribution? But you can split your contribution between the two types of IRAs. You don’t really have to choose. Who might that be a good strategy for?

Benz: Right. It’s a good question, Susan, because you normally hear, well, if you think your tax bracket will be higher in retirement, you’re better off selecting Roth today because you’re paying taxes at a relatively low rate to when you pull them out in the future. But if you are expecting that your income tax bracket will drop in retirement, you’re better off taking the deduction today, assuming you’d qualify to make a deduction. So that’s a fork in the road. And a lot of people just say, “I have no idea,” especially if maybe you are 30 or 40 years from retirement. Splitting the difference, I think, is a perfectly legitimate way to go. Maybe you’re earning a little bit of a tax break by making the traditional deductible contribution, but then you’re getting the rest of it over into the Roth column. So, with contribution limits at $7,000 today, you could do $3,500 in the traditional deductible IRA and another $3,500 in Roth.

Moving Unused Funds From a 529 College Savings Plan

Dziubinski: One brand new option for IRA contributions is to be able to move unused funds from a 529 college savings plan into a Roth IRA. Who should consider that?

Benz: Well, so this is a rarefied situation where someone has overfunded a 529 college savings plan. Most people do not find themselves in that situation. But it’s a neat feature that was part of the Secure 2.0 Act that does allow people who have overfunded a 529. So, say you are the beneficiary, the account owner of that 529 plan, you’re subject to those annual IRA contribution limits, but you could move some of the funds each year into a Roth IRA. And there is a limit on how much you can move. So, it’s I think a $35,000 lifetime limit in terms of how much. So, you can’t super overfund the 529, but nonetheless, a really neat mechanism and I think should give parents maybe with younger kids a little bit more comfort in taking advantage of that 529 college savings vehicle. Worst-case scenario, best-case scenario, your child gets a scholarship, or you know, whatever the case might be, the risks of overfunding that 529 with this escape hatch, I think, are less than they once were.

Can Children Contribute to IRAs?

Dziubinski: And then finally, people might not realize that children can contribute to IRAs in some cases. How does that work?

Benz: Right. So, I keep hammering on this earned-income requirement, which is an important component. So, your child needs to have earned income in order for the contribution to go through, and the earned income must be equal to or greater than whatever contribution you’re making. But I think the thing that people sometimes miss in this context is, say, your college kid has a summer job and maybe they make $4,000 or $5,000 in that summer job. Well, maybe that money is long gone. You’ve got a new iPhone and whatever else. But the good news is if you as a parent want to try to match them on whatever earned income they came up with over the summer and put the money in an IRA, you can go ahead and do that. It doesn’t have to be the child’s own funds. It’s just as important that they have enough earned income to cover whatever contribution that you want to make. So, it’s a really nice way to kick-start retirement savings for kids, grandkids, whatever the case might be.

Dziubinski: Well, Christine, thanks for shining the light on some of these little-known opportunities really when it comes to your IRA.

Benz: Thank you so much, Susan.

Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.

Watch “Backdoor Roth IRAs: What to Know Before Stepping Through” for more from Christine Benz.