Question

Can an individual make a contribution to an IRA based on unemployment compensation proceeds received? What specifically would you convey to your client based on your tax research results?

Answer 1

Generally, individuals who are unemployed are not allowed to contribute to retirement accounts such as IRAs because they do not have eligible compensation. However, there is an exception for individuals with spouses who are employed and meet certain requirements. The employed spouse is allowed to make an IRA contribution on behalf of a non-working spouse or a spouse who has little income. These contributions are referred to as "spousal IRA contributions." Here we review the requirements for making spousal IRA contributions.

Eligibility

To make an IRA contribution for your spouse, you must meet the following requirements:

?You must be married.
?You must file a joint income-tax return.
?You must have compensation or earned income of at least the amount you contribute to your IRAs.

Age Limit

If you decide to fund a Traditional IRA for your spouse, he or she must be under age 70½ for the year for which the contribution is being made. No age limits apply to Roth IRA contributions.

Compensation Limit

While there is no cap on the amount you may earn to fund a Traditional IRA, this is not so for a Roth IRA. You may contribute 100% of your compensation or the tax year's IRA contribution limit, whichever is less, to your IRA. Bear in mind that the contribution limit that applies to you also applies to your spouse.

For 2017 and 2018, the contribution limit is $5,500 for most Americans ($6,500 for those over 50)

The penalty tax kicks in when you take a distribution before reaching a certain age, usually 59½, although there are some exceptions to this additional tax.

The penalty is 10 percent of the taxable amount when you take an early distribution from an individual retirement account (IRA), a Roth IRA, a 401(k), a 403(b), or another qualified retirement plan before reaching age 59½. The taxable amount must also be included in your taxable income.

The additional tax increases to 25 percent if you take the distribution from a SIMPLE IRA within two years of the date you first began participating in the plan.

Exceptions

There are two sets of exceptions to these rules. The first applies to individual retirement accounts, both traditional and Roth IRAs. The second affects 401(k) and 403(b) retirement plans.

Exceptions for early distributions from IRAs include:

You had a "direct rollover" to your new retirement account using a trustee-to-trustee transfer.

You received a payment but rolled the money over into another qualified retirement account within 60 days.
You were permanently or totally disabled.
You were unemployed and used the money to pay for health insurance premiums.
You paid for college expenses for yourself or a dependent or a grandchild.
You received the distribution as part of "substantially equal payments" over your lifetime.

Qualified first-time homebuyers can take distributions of up to $10,000.

You paid for medical expenses exceeding 10 percent of your adjusted gross income.
The IRS levied your retirement account to pay off tax debts.
The distribution represents a return of nondeductible contributions.
It was a non-qualified distribution from a Roth IRA.