Investing in an IRA for a family member (spouse, child, grandchild) is a great idea that will help them be financially secure during retirement and could lower your tax bill. As always, there are rules that govern these types of IRA investments.
If your spouse leaves the workforce for any reason, the working spouse can contribute to an IRA in the spouse’s name. Usually, you need earned income (salary and other compensation for working) to fund an IRA. However, the IRS allows a spouse to fund an IRA for his or her spouse. So, if you are unemployed or a stay at home parent, you can still save for retirement.
The maximum contribution to an IRA for 2013 is $5,500 plus an additional $1,000 if you are at least age 50. There are two types of IRAs you can contribute to: the traditional IRA which is funded with pre-tax dollars and the Roth option, which uses after-tax dollars. The major difference is when you pay taxes. Traditional plan contributions are tax-deferred and may be tax deductible. You pay taxes when you withdraw money during retirement. You don’t get a tax break with Roth contributions, however withdrawals are generally tax-free, both principle and earnings.
There are restrictions of course. First off, if your spouse is age 70 1/2 or older, he or she cannot contribute to a traditional plan. There are also income limitations based on certain factors as well. If neither spouse has access to an employer-sponsored plan, such as a 401k, then contributions for both spouses are fully deductible, no matter their income. If each spouse has another plan available to them, they can only fully deduct their contributions if they make less than $92,000 per year. The deduction phases out up to $112,000.
If only one spouse has a plan available to him or her (as is usually the case in this situation), the working spouse can deduct up to the $92,000 phase out amount. However, the non-working spouse can deduct even if they earn up to $173,000 (phaseout occurs up to $183,000).
The Roth option is good for those people who expect to pay higher taxes later on in life. Further, if you don’t think you’ll need your IRA funds during retirement, a Roth is a great way to set your heirs up. The income limit to contribute to a Roth IRA is $183,000 for couples filing jointly.
If you want to invest in an IRA for a child or grandchild, it’s best to open a Roth IRA for them. They probably aren’t making too much money so the tax break they would get for a traditional IRA is almost nothing. The Roth will grow tax-free and they can withdraw contributions anytime tax- and penalty-free. Plus, if they are using the money for higher education, earning may be penalty-free as well.
The one caveat for funding a child’s IRA is that they must have earned income. This is defined as wages earned from a job, baby sitting, mowing lawns or even performing chores around the house ( so long as they are reasonably compensated for the tasks performed). You cannot contribute more than the child earns during the year. If he or she earns $2,000 at a summer job, that’s the max he or she can contribute to an IRA.
If you have any questions about this or are looking to set up an IRA for a family member, contact the tax experts at the IRA Financial Group who will set you on the right course of action for you and your family!