Here's a Tax Break That Married Couples Often Overlook
Retirement | IRA | Roth | Married | Spouse | August 7, 2024
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Saving for retirement can be tough for married spouses who stay home to care for family or otherwise have scant income. But there is a tax break offered by the Internal Revenue Service that can help them and their partner save for retirement: a spousal IRA.
Spousal individual retirement accounts allow a working spouse to contribute to a nonworking or low-earning spouse’s retirement savings. They can be set up as a traditional IRA or Roth IRA, which allow couples to save for retirement on a tax-deferred or tax-free basis, respectively.
Besides helping a couple contribute more to their retirement savings annually while reaping the tax advantages, these vehicles have a psychological benefit, financial planners say. “Often, it helps the nonworking or low-earning spouse to feel good about their value they bring to the household, and be more involved in the retirement-savings process,” says Katherine Tierney, a certified financial planner and senior retirement strategist at Edward Jones.
What’s more, when nonworking or low-earning spouses maintain such an account it offers some financial independence and ensures they have access to retirement funds should they become widowed or divorced since the assets are in their name, wealth managers say.
There is just one big problem with spousal IRAs: “Despite the advantages, not many people know about them,” says Stacy Miller, a certified financial planner and chief executive of BayView Financial Planning in Tampa, Fla.
How they work
A spousal IRA isn’t a unique type of IRA or a joint account, but instead it is a separate IRA opened and owned in the name of the nonworking or low-income earning spouse. To qualify for a spousal IRA, spouses must file taxes jointly as a married couple. At least one spouse must have taxable compensation. Opening a spousal IRA is no different from opening a regular IRA.
Lindsay Theodore, a certified financial planner at T. Rowe Price, says that spousal contributions also can be made to a nonworking or low-earning spouse’s existing IRA.
In 2024, each spouse under age 50 can contribute $7,000 annually to an IRA, or $8,000 annually for those over age 50, but the total contribution can’t exceed the taxable earned income reported on the couple’s tax return. Otherwise, the IRS limits contributions based on their earned income.
Roth or traditional?
Deciding whether to open a Roth or traditional IRA depends on a couple’s tax situation and financial goals.
Traditional IRA contributions typically are tax deductible the year in which they are made and are beneficial during high-income earning years. Contributions grow tax-free until they are withdrawn during retirement.
Roth IRA contributions aren’t tax deductible the year in which they are made, but qualified contributions plus any earnings grow tax-free and are withdrawn tax-free in retirement as long as the couple follows IRS rules. Among them: a five-year rule that says a contributor can’t withdraw earnings tax-free until it has been at least five years since he or she first contributed to a Roth IRA.
There are penalties for withdrawals on traditional IRAs before age 59½ unless the owner qualifies for an exception, and he or she must begin taking the annual withdrawals known as required minimum distributions from these plans the year he or she turns 73 as part of the Secure 2.0 Act (or 75 beginning in 2033). Roth IRAs don’t require RMDs until after the death of the owner for 2024 and later years. However, beneficiaries of a Roth IRA generally will need to take RMDs to avoid penalties, although there is an exception for spouses.
Keep in mind that IRS rules on IRAs can be complicated. For example, there are limits to modified adjusted gross income for Roth IRA contributions. In tax year 2024, your modified adjusted income must be under $240,000 for married couples filing jointly.
Another rule that is often overlooked by individual investors is on traditional IRAs. If a person has a traditional spousal IRA and his or her spouse were covered by an employer retirement plan, he or she may be entitled to only a partial tax deduction, or none at all, depending on income and filing status.
“Tax considerations are key when deciding whether to open a spousal IRA,” says Robin Snell, owner of Nested Financial & Tax Planning in Palm Harbor, Fla. “Because of taxes and penalties on early withdrawals, it may make more sense to save in a taxable brokerage account if you think you will need to tap the account before retirement. It all depends on a couple’s financial scenario.”
The power of compounding
Adding a spousal IRA can significantly boost savings by the time a couple is ready to retire.
“While the additional savings may seem small, they have the power to accumulate over time and make a big difference,” says Cassandra Rupp, senior wealth adviser at Vanguard.
T. Rowe Price did a hypothetical analysis that found that over 20 years of earnings on contributions to an IRA could more than double the account balance assuming an annual contribution of $7,000 was made to a spousal IRA with an average annual return of 7%. Over that period, earnings on $140,000 of contributions would total $167,056 and the balance would be $307,056.
“I recommend starting early and contributing as often as your budget allows,” says Andrew Crowell, vice chairman of wealth management at D.A. Davidson. “Adjust your allocation as your age and time horizon changes.”
Credit goes to Lori Ioannou, published June 5, 2024 in The Wall Street Journal
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This Week’s Author, Mark Bradstreet