Q.: I read that you need $6,000 of income to make an IRA contribution. Is that per person? My wife did not work in 2020.
—Mark in San Diego
A.: Mark, each person is limited to a maximum contribution of 100% of earned income or $6,000 ($7,000 if age 50 or more). The contribution can go into an IRA, a Roth IRA, or a combination of the two as long as the total contributed does not exceed the limit.
The contribution limit is independent of any other retirement plans you or your wife may be covered by like a 401(k). Those other retirement plans affect your ability to deduct your contribution for tax purposes but do not affect your ability to contribute. Anyone with enough earned income can contribute to an IRA. It may not be a deductible contribution, but a contribution can be made.
For married couples, this means up to $6,000 (or $7,000 depending on age), can be contributed for each spouse for a maximum total of $12,000-$14,000. The earned income does not have to be earned by any particular member of the couple if filing a joint return. If either spouse earns the needed $12,000-$14,000, or the combined earned income of both spouses totals $12,000-$14,000, both spouses can make their $6,000 ($7,000) contribution.
For purposes of eligibility for IRA/Roth IRA contributions earned Income is traditionally from work so it includes salaries, wages, tips, bonuses, commissions, and net positive income from self-employment. It also includes taxable alimony received. Less common but also eligible is difficulty-of-care payments for foster care workers and taxable non-tuition fellowship and stipend payments.
That leaves a lot of other income sources that does NOT qualify. For instance, items you find on a 1099-INT, 1099-DIV like interest income and dividends on stocks or other investments do not qualify. Rental income and capital gains from the sale of investments or property does not count. Nor do pension payments, profit sharing, IRA distributions, or distributions from retirement accounts or annuities.
Social Security, deferred compensation, unemployment compensation, child support, disability insurance income and life insurance proceeds are also excluded.
If you contribute more than you are allowed to contribute, an “excess contribution” has occurred and it will need to be corrected.
For a 2020 contribution, no penalty will apply if it is corrected by April 15, 2021. The penalty for leaving an excess contribution in an IRA or Roth IRA is 6% of the excess for every year the excess remains in the account. That can add up. To correct an excess for earlier years, you file Form 5329 which will place information on Schedule 2 on your 1040. The exact fix can vary quite a bit based on timing, amount, age, and whether you apply the excess to a later year contribution. The firm holding the account and your advisor should be able to help you get the correct amount removed.
If you have a question for Dan, please email him with “MarketWatch Q&A” on the subject line.
Dan Moisand is a financial planner with Moisand Fitzgerald Tamayo. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some questions are edited for brevity.