As tax season is currently in full swing, many individuals are looking for ways to lower their tax bill or increase their refund before the filing deadline of April 15, 2024. For some married couples, one excellent strategy for reducing taxes and boosting retirement savings is with spousal IRA contributions.
What is a spousal IRA contribution?
A spousal IRA contribution, very simply put, is a way for a working spouse to contribute to an Individual Retirement Account (IRA) on behalf of a non-working or low-earning spouse. Often, people may think that the working spouse is the one who must own the retirement account and make the contributions. In some cases that may be true, such as with an employer-sponsored retirement plan like a 401(k). However, a spousal IRA contribution allows for a spouse with no earned income to have an IRA in their own name and receive contributions. This valuable tool can help married couples double their IRA contributions in a given year even if one spouse does not have earned income.
Who is eligible to make a spousal IRA contribution?
This option is only available to couples who are married and filing taxes jointly. In addition, the couple must have earned income equal to or greater than the contribution amount. For 2023 the maximum contribution is $6,500 (or $7,500 if age 50 or older) per individual. For example, if both spouses are age 50 or older, the couple may be able to contribute a combined $15,000 toward their IRAs for 2023 ($7,500 to each IRA).
It is important to emphasize that each spouse must have their own IRA in their own name.
Following the same example, it would not be permitted to contribute $15,000 to a single IRA and claim that $7,500 is for each spouse.
What if an individual has multiple IRAs?
It is common for individuals to have multiple IRAs in their own name. Sometimes there is a different financial advisor or investment strategy assigned to each IRA. However, for the purposes of contributions and other tax rules, these separate IRAs are considered as one. What that means is investors may not contribute the $6,500 maximum to each IRA in their own name. The annual totals are applied to all IRAs that are held in an individual’s name.
Is there a special type of account known as a “spousal IRA”? Do spousal contributions work for Roth IRAs?
There is no special type of account for spousal IRAs. The spousal IRA contribution can be made to a traditional IRA or to a Roth IRA. Deciding between using a traditional IRA and a Roth IRA requires consideration of each couple’s preference and financial situation. There are also some important phaseouts and limitations (see below) to account for.
What is the tax deductibility of traditional IRA contributions?
Typically, a traditional IRA contribution is done with the intention of deferring income tax. A tax-deductible contribution means the individual is not taxed on those dollars (e.g., $6,500 in 2023) until the funds are later withdrawn (usually in retirement). However, traditional IRA contributions are not always tax-deductible. The rules that determine whether the contribution is deductible can be complicated, but below is a summary.
Traditional IRA deduction phaseout
If an individual is an active participant in an employer-sponsored retirement plan (this may include but is not limited to a 401(k), 403(b), SEP IRA, or defined benefit pension plan), then their Modified Adjusted Gross Income (MAGI) and tax filing status will determine whether their traditional IRA contributions are tax-deductible.
Traditional IRA deduction phaseout ranges for 2023 based on MAGI:
- Single: $73,000 – $83,000 (i.e., there is no deduction allowed when MAGI exceeds $83,000)
- Married Filing Jointly: $116,000 – $136,000
- Spousal IRA: $218,000 – $228,000
- Married Filing Separately: $0 – $10,000
An important distinction from above is that the “Married Filing Jointly” phaseout is different than the “Spousal IRA” phaseout. The former is applied to the individual who is an active participant while the latter is applied to the spouse of an active participant (assuming that spouse is not a participant in a plan of their own employer). This means that a couple with one working spouse who is an active participant and one spouse with no earnings may be subject to two separate phaseouts.
Another important note is that these phaseout ranges are limiting the ability to deduct traditional IRA contributions, not the ability to make contributions. If a contribution is determined to be non-deductible, it can still go into the IRA but there is no tax deduction. This can lead to complications and difficult record-keeping in future years.
If neither an individual nor their spouse are an active participant in an employer-sponsored retirement plan, then the income phaseout ranges will not apply – they may make tax-deductible traditional IRA contributions no matter how high their MAGI is.
How does one know if they are an active participant in an employer-sponsored retirement plan?
Having a 401(k) or other retirement account does not necessarily mean one is an active participant. For example, having a 401(k) with a prior employer from before 2023 may not be considered. One good way to check is to look at the W-2 you receive from your employer(s) and look for the “Retirement Plan” box (Box 13 on the 2023 W-2). This box should be checked if the employee is an active participant.
The IRS provides additional guidance at this link.
Roth IRA contribution phaseout
Unlike traditional IRAs, contributions to Roth IRAs are never tax-deductible. Individuals put after-tax dollars into a Roth IRA and then the earnings grow tax-free (subject to certain rules).
However, there are still MAGI phaseouts to consider for Roth IRAs. These phaseouts determine whether an individual is allowed to contribute to a Roth IRA at all. Unlike the traditional IRA rules, these apply regardless of whether an individual is an active participant in a retirement plan.
Said another way, Roth IRA contribution phaseouts simply look at MAGI and tax filing status.
Roth IRA contribution phaseout ranges for 2023 based on Modified Adjusted Gross Income:
- Single: $138,000 – $153,000 (i.e., there is no contribution allowed when MAGI exceeds $153,000)
- Married Filing Jointly: $218,000 – $228,000
- Spousal IRA: $218,000 – $228,000
- Married Filing Separately: $0 – $10,000
How does one decide between a traditional IRA and a Roth IRA?
Again, choosing between a traditional IRA and a Roth IRA is a decision that should be done with careful consideration of one’s own preferences and financial situation. Generally speaking, many individuals can benefit from maximizing tax deductions in years during which they expect to pay higher income tax rates and paying taxes in years when lower income taxes are expected. This would mean making deductible traditional IRA contributions in high income tax years and Roth IRA contributions in lower income tax years. However, this scenario really oversimplifies the reality of financial and tax planning.
Another general note is that if a traditional IRA contribution will not be deemed as deductible, it may be advantageous to explore other options. If the MAGI for a married couple is below $218,000 for 2023, making a Roth IRA contribution can be a simple and effective solution. Another strategy that is frequently employed is the “Backdoor Roth IRA” in which individuals make non-deductible contributions to a traditional IRA and later convert the account to a Roth IRA. This comes with its own set of limitations and complications (look up “Backdoor Roth IRA pro rata rule” if you’re interested in one such complication).
In some cases, neither a traditional IRA nor a Roth IRA may be feasible. It is important to also consider employer-sponsored retirement plans and other solutions that may provide avenues for tax and retirement benefits.
Contribution Deadlines
The deadline for a spousal IRA contribution is the same as for an individual contributing to their own IRA. It must be made by the tax filing deadline for the year, typically April 15th of the following year. For the 2023 tax year, the normal deadline is April 15th, 2024.
Contribution Limits
Like many tax matters, contribution limits and income phaseouts frequently change over time. The new numbers are already released for 2024 and include an increase in IRA contribution limits. For 2024, the IRA contribution limit is up to $7,000 ($8,000 age 50 or older) per individual.
Conclusion
Traditional and Roth IRAs can be valuable tools for saving money on taxes and increasing retirement savings. Spousal IRA contributions are an avenue for some married couples to set aside even more tax-advantaged money for the future. The best option will be different for different couples, and individuals should carefully consider their own circumstances before making investment and tax decisions.
This article is intended to be used for educational purposes and is by no means an extensive guide on taxes, nor is it tax advice. Tax and financial specialists can be a great resource for those who need additional assistance.
