This is a powerful advantage for households in which only one spouse works outside the home, since these accounts double the couple’s ability to save money for retirement through an individual retirement account.
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Why Retirement Savings for the Nonworking Spouse?
Too often, nonworking spouses assume that they can rely on their working spouses for retirement security. In fact, one 2015 survey showed that 75 percent of U.S. homemakers will rely heavily on their spouse’s income in retirement.
While we would all like to think that marriage is forever and that a spouse’s retirement savings will be available in our own old age, that may not be the case. Death and divorce are just two scenarios that could wreck this plan.
This is why it’s important for stay-at-home moms and other nonworking spouses to have retirement savings in their own names. After all, whether a nonworking spouse is going to medical school full-time or staying at home to manage the house and raise the children, they are making serious contributions to the family. Those contributions deserve to come with some security for the future.
Though most one-income families may be unable to afford to fully fund two IRAs plus a work-sponsored 401(k), these families should consider splitting IRA contributions between the working and nonworking spouse, rather than keeping all retirement savings in the working spouse’s name.
Spousal IRA Basics
For the most part, spousal IRAs work the same way as traditional IRAs.
Contribution limits: For 2015 and 2016, a nonworking spouse can contribute and deduct up to $5,500 toward a spousal IRA. If the nonworking spouse is age 50 or older, the contribution is increased to $6,500.
Account type: A spousal IRA does not need to be set up as a standalone account. If the nonworking spouse has an existing IRA from a previous career, spousal IRA contributions can continue to be contributed to that account. And just as is the case with other IRAs, the spousal IRA can be in a self-directed investment account.
Tax deferral of investment earnings: Just as is the case with other IRAs, investment earnings on a spousal IRA are tax-deferred until they are withdrawn. This is true whether contributions to the account are tax-deductible or not.
Investment options: A spousal IRA can be invested in an almost unlimited number of investments, including stocks, bonds, mutual funds, exchange traded funds, and real estate investment trusts. The only investments you can’t make are the short list of prohibited IRA investments that few people have any interest in holding anyway.
Resource: A List of IRA Investment Options
Withdrawal rules: You can begin taking withdrawals from a spousal IRA at age 59 1/2. If you begin taking them sooner, you may be subject to the IRS early withdrawal penalty of 10% of the amount withdrawn. Spousal IRAs are also subject to required minimum distributions (RMDs), which means that you must begin taking distributions once you reach age 70 1/2.
Income tax filing status: In order to qualify for a spousal IRA, a couple must file as married filing jointly. This makes sense, since the spousal IRA is reliant upon the income status of the working spouse. By contrast, if you file married filing separately, the spousal IRA is not allowed.
Account ownership: Despite the fact that the working spouse must bring in an income to fund the spousal IRA, the account is a distinct account owned entirely by the nonworking spouse, who will get the benefit of plan distributions upon retirement. And as is the case with all retirement plans, there is no joint ownership of a spousal IRA.
Contribution due dates: You can make a contribution to a spousal IRA up until the tax filing deadline for the tax year in question. For example, in order to make a contribution to a spousal IRA for 2015, you can make the contribution up until April 18, 2016, which is the filing deadline for 2015.
Despite the general similarities between spousal IRAs and traditional IRAs, there is one major difference that makes the spousal IRA standout.
The Spouse Doesn’t Need to Have an Earned Income
The general rule with IRAs of any type is that you must have earned income in order to be able to make a contribution to the plan. That income can be from a job, a business, or some other form of revenue that requires active participation. Many people know this is a rule for IRAs, so stay-at-home moms, homemakers, and other spouses who don’t bring in an outside income assume they have no retirement savings options.
But the spousal IRA is the exception to the earned income rule. The spouse does not need to have an earned income—or any income at all—in order to qualify to make a spousal IRA contribution. And the contribution may still be tax-deductible!
Here’s how it works: The earned income requirement actually does apply to the spousal IRA, but the work-around is that the income does not have to be received by the spouse. As long as the working spouse earns enough income to fund a spousal IRA, plus his or her own retirement contributions, he or she can contribute to the spousal IRA.
If both the working spouse and the non-working spouse make IRA contributions, the working spouse must have sufficient earned income to cover both contributions. If not, the contributions will be permitted only up to the amount of the working spouse’s earned income.
For example, let’s assume the working spouse and the nonworking spouse each make a $5,500 contribution to their respective IRA accounts. As long as the working spouse earns at least $11,000 for the year when the contributions are made, the contributions will be permitted.
By contrast, if the couple make the same contributions as above, but the working spouse earned only $8,000, then the total amount of IRA contributions by the couple cannot exceed $8,000. Also, it does not matter how the contribution is split; one spouse can make a contribution of $5,500, while the other makes a contribution of $2,500.
The whole purpose of the spousal IRA is to provide a nonworking spouse with the benefit of contributing to an IRA account, even if he or she does not earn an income from outside the household.
Spousal IRA Contributions May Also Be Tax Deductible
Just as is the case with traditional IRAs, spousal IRA contributions may also be tax-deductible. That will certainly be the case if neither spouse is covered by an employer-sponsored retirement plan. But even if there is an employer retirement plan, contributions may still be tax-deductible subject to income limits.
For 2015 and 2016, you can make a tax-deductible spousal IRA contribution—even if one spouse is covered by an employer plan—if you file as married filing jointly, and your annual income does not exceed $98,000.
Between $98,000 and $118,000, the contribution will still be partially tax deductible. Beyond $118,000, the deduction disappears completely. That is, you can still make the spousal IRA contribution, but it will not be deductible from your income.
Spousal Roth IRAs
A nonworking spouse can also contribute to a Roth IRA, with the same benefits and limits that apply to a Roth IRA taken by the working spouse. A Roth IRA does not permit contributions to be deducted from income for tax purposes when made, but does allow for virtually tax-free withdrawals from the plan, as long as you are at least 59 1/2 years old, and have had a Roth IRA established for at least five years when you begin taking distributions.
The contribution limits for a Roth IRA are the same as they are for a traditional IRA. There are also income limits, beyond which you cannot make a contribution at all. For 2015, the income limit to make a full contribution to a Roth IRA plan is $183,000. Between $183,000 and $193,000, the contribution is gradually phased out. Beyond $193,000, Roth IRA contributions are no longer allowed.
Is a Spousal IRA Worth Taking?
The best way to demonstrate the value of the spousal IRA is with an example. Let’s say that a wife and mother, age 25, makes the decision to spend the next 10 years staying at home taking care of the couple’s children. 10 years will be enough time for the youngest child to be in school full time, freeing up mom to return to the workforce.
In order not to lose retirement benefits during her time outside the formal workforce, she and her husband decide that they will do a spousal IRA for each year that she is at home, working to take care of the children. She will contribute $5,500 each year for 10 years, out of her husband’s earned income, for a total of $55,000. The average annual rate of return on investment will be 8%.
After ten years, she finally returns to the workforce, but during that time her spousal IRA has grown to $83,850.
She is now 35, and has 30 years until she retires. Over that time span, and with a continued average annual rate of return of 8%, her spousal IRA will grow to $843,749. And that’s without adding any additional contributions to the plan after the first ten years.
Supplemented by her participation in her new employer’s 401(k) plan, her spousal IRA will provide her and her husband with a very comfortable retirement. It will be as if she never left the formal workforce to take care of her children.
And that’s the basic purpose of a spousal IRA. Have you looked into setting one up?