What is a Spousal IRA?
The single wage earner family is at a severe disadvantage when it comes to saving for retirement. Even if one spouse earns a high salary and makes the maximum contribution to an IRA, the earnings limits under IRA’s and other tax deferred programs make it difficult to save sufficiently for both partners. The stay at home spouse gets all the difficult work raising the kids, with no pay and no retirement savings.
Congress attempted to rectify this situation to a certain extent by creating the Spousal IRA.
General Rules for a Spousal IRA
If you are a married to a person who earns wages or who has earned income, you are eligible to open an IRA even if you don’t have any earned income yourself. In this type of IRA, you open the IRA in your name (the non-worker) and your spouse, who earns income, makes contributions to your IRA account.
There are certain rules which apply to Spousal IRA’s that don’t apply to regular IRAs. Under a Spousal IRA, you have to be married and file a joint income tax return with your spouse. The Spousal IRA is not allowed if you file separately from your spouse or if your spouse files as head of household.
Traditional Spousal IRA
The contribution and income limits for a Traditional Spousal IRA are the same as under a Traditional IRA. The working spouse contributes on behalf of the non-working spouse. The contribution can be up to $5,000 ($6,000 if over age 50) assuming the working spouse has enough income to cover the contribution. These contributions are fully deductible on the joint tax return if the working spouse has Adjusted Gross Income of under $169,000. The contribution gets phased out if income is between $169,000 and $179,000. The contribution is not deductible if the AGI is over $179,000. Adjusted Gross Income is different than Gross Income. Simply look at line 34 on Form 1040 for this figure.
If the working spouse is not covered under a retirement plan where he works, you can claim the full deduction regardless of income level. Your contributions will grow tax-deferred until your retirement after at least age 59 1/2. When you make withdrawals at retirement, the full amount of withdrawal will be taxed as ordinary income.
Roth Spousal IRA
If tax-free withdrawals at retirement are more appealing than a current tax deduction, the working spouse can contribute on behalf of the non-working spouse to a Roth Spousal IRA. The Roth Spousal IRA permits a contribution of up to $5,000 ($6,000 if over age 50). The contribution limits are the same as under the Traditional Spousal IRA. Full contribution under AGI of $169,000, phased out between $169,000 – $179,000 and no contribution allowed over $179,000.
The contributions into the Roth IRA grow completely tax-free at retirement.
Special Consideration if Your Spouse Should Pass Away
Should your wage earning spouse pass away, your spousal IRA is in your name and therefore there is no financial or tax effect. However, if you inherit your spouse’s IRA you must take action if you are age 70 ½. You need to withdraw at least the minimum required amount from the inherited IRA or the IRS will charge a penalty equal to 50% of the shortfall. This is a very stiff penalty one of the harshest is the IRS code. See your accountant and have him calculate the amount that you need to withdraw.
There has been an ongoing legal issue with inherited IRAs when a trust or estate has been named as beneficiary. The rules are silent on whether a surviving spouse can make an IRA rollover of these assets. Most custodians get nervous if the rules are not clear and may refuse to let the surviving spouse do a rollover. However, a number of custodians and estate executors have applied to the IRS for Private Letter Rulings, which are rulings by the IRS based on the facts of a particular case. In 75 rulings since 2002, all of the Private Letter Rulings agreed that surviving spouses can do an IRA rollover even though the trust or estate might be the beneficiary of the IRA. This assumes that the surviving spouse is, in effect, the actual beneficiary of the trust and has the power to perform all actions under the trust.
IRA Rules Refresher
In case you don’t remember or haven’t read the other Traditional IRA vs Roth IRA rules, the rules will be reviewed below for convenience.
- Traditional IRA allows pre-tax contributions. Your contributions grow tax deferred and withdrawals are taxed as ordinary income.
- .oth IRA allows after-tax contributions. Your contributions grow tax free and withdrawals are not taxed at all.
- Withdrawals can start at age 59 ½ without any penalties being imposed by the IRS. (There are other events that allow for penalty-free withdrawals before that age 59 ½ such as disability or death).
- You must start minimum required distributions at age 70 1/2.
- IRA contributions must be made with cash or a check. You cannot use make contributions on credit.