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HomeInvestingSpousal IRA Strategies | White Coat Investor

Spousal IRA Strategies | White Coat Investor


By Dr. James M. Dahle, WCI Founder

One great financial benefit of being married is that the IRS allows a non-working spouse to contribute to an Individual Retirement Arrangement (IRA) using the working spouse’s income. This is called a spousal IRA.

 

What Is a Spousal IRA?

A spousal IRA is not a joint account. The first letter of IRA stands for INDIVIDUAL. Retirement accounts always belong to a single person.

Other than the source of income from which the contribution is made, a spousal IRA is exactly the same as any other IRA. The 2022 contribution limit is the same—$6,000 ($7,000 if 50+). It can be made to a traditional or Roth IRA. Income limits for traditional IRA deductibility and direct Roth IRA contributions are exactly the same. If income is too high, the Backdoor Roth IRA process can still be employed to contribute indirectly to a Roth IRA.

 

How Does a Spousal IRA Work?

While not usually an issue in the WCI community, the working spouse must generate enough taxable income to “cover” both contributions, so $12,000 if both spouses are under 50 and up to $14,000 if both are over 50.

The most unique spousal IRA rule is that the couple must file their taxes jointly to make the contribution. You cannot file Married Filing Separately (MFS) AND make a spousal IRA contribution. This rule is where white coat investors can occasionally get burned. Some doctors going for student loan forgiveness employ an MFS strategy to minimize IDR payments and maximize forgiveness. Realize those strategies eliminate the ability to make IRA contributions for your spouse.

 

The Nitty-Gritty

In 2013, Kay Bailey Hutchison, a Republican US senator from Texas from 1993-2013, had her name attached to the Internal Revenue Code section 219(c). This section allows for spousal IRA contributions. She was apparently a big proponent for stay-at-home spouses to still save for retirement even if they didn’t have earned income. Want even more trivia? Her first marriage (two years) was to a medical student, and she serves as an honorary board member of the Multiple Myeloma Foundation.

According to IRS Publication 590-B, except under the “Kay Bailey Hutchison IRA Contribution Limit,” each spouse figures their IRA contribution amount based only on their own earnings, even in community property states where IDR payments are calculated using half of the household income. However, if you are filing MFS, the “Kay Bailey Hutchison IRA Contribution Limit” does not apply. Now, your contribution may be limited by your income. If you made less than $6,000, you cannot make a full $6,000 contribution.

Let me say that again because it is important:

If your spouse does not work and you file MFS, you just gave away the ability to do a spousal IRA contribution.

 

Traditional IRA Deductibility for Married People

IRA deductibility rules get really complicated when you’re married. They depend on income (technically, Modified Adjusted Gross Income or MAGI); filing status; whether you lived with your spouse during the year; and whether you and/or your spouse has a retirement plan available at work, such as a 401(k). Here were the rules for the 2021 tax return that was filed in 2022:

  1. If neither of you has a retirement plan available at work, traditional IRA contributions are fully deductible for both of you.
  2. If you are filing MFJ, you do not have a plan at work but your spouse does, then your ability to deduct an IRA contribution phases out at a MAGI between $198,000-$208,000.
  3. If you are filing MFJ and have a plan at work (whether your spouse does or not), then your ability to deduct an IRA contribution phases out at a MAGI between $109,000-$129,000.
  4. If you are filing MFS and lived with your spouse at any point during the year, if either you or your spouse has a plan at work, then your ability to deduct an IRA contribution phases out at a MAGI between $0-$10,000.
  5. If you are filing MFS, did not live with your spouse at any point during the year, and you have a plan at work, then your ability to deduct an IRA contribution phases out at a MAGI between $68,000-$78,000 (the same as a single person).
  6. If you are filing MFS, did not live with your spouse at any point during the year, and do not have a plan at work (whether your spouse does or not), then traditional IRA contributions are fully deductible to you.

Confused? I don’t blame you.

Practically speaking, this is not a big issue for white coat investors. Most of us don’t want a traditional IRA anyway. Even if you can deduct an IRA contribution now, you will likely want to make indirect (Backdoor) Roth IRA contributions eventually. The presence of IRA money that hasn’t been transferred into a 401(k) or converted to a Roth IRA will cause those contributions (technically the conversion step of the process) to be pro-rated.

But keep in mind that if you do a Backdoor Roth IRA and that IRA contribution was partially or completely deductible, then the conversion step will be taxable. It all works out the same in the end (exactly the same as a direct Roth IRA contribution), but the tax forms will look a little different. Your deduction for the contribution will equal the taxes due on the conversion, assuming no gain (or loss) between the contribution and the conversion steps of the Backdoor Roth IRA process.

 

Direct Roth IRA Contribution Limits

Guess what else gets weird when you file MFS? That’s right, whether you have to fund your Roth IRA directly or indirectly (i.e. through the Backdoor Roth IRA).

If you file MFJ, your ability to contribute directly to a Roth IRA phases out at a MAGI between $204,000-$214,000. However, if you file MFS, that ability phases out at a MAGI between $0-$10,000. Practically speaking, this means . . .

If you file your taxes MFS, you need to do your Roth IRA contribution indirectly (via the Backdoor Roth IRA process).

Roth IRA contributions are not affected by the presence of a plan at work or by whether you live with your spouse. It is all dependent on your filing status and income. Let me say it one more time because it’s important:

If you file your taxes MFS, you need to do your Roth IRA contribution indirectly (via the Backdoor Roth IRA process).

 

Inheriting an IRA from Your Spouse

spousal ira

There are also some unique rules about inheriting an IRA from your spouse. In fact, inherited IRA rules are highly variable depending on your relationship with the previous IRA owner.

 

Unrelated to Previous Owner

Under current law (i.e. you inherited an IRA from someone who died in 2020 or later), you can “stretch” a traditional or Roth IRA for an additional 10 years of tax and asset protection. No withdrawals (i.e. Required Minimum Distributions or RMDs) are required during those 10 years, although many who inherit a tax-deferred IRA may wish to spread the withdrawals out over a few or even all 10 years. You can simply pull it all out 10 years after the death of the original IRA owner. No penalties apply, no matter your age, although you will pay taxes at ordinary income tax rates on withdrawals of any tax-deferred money. We’ll call this Option 1.

 

Eligible Designated Beneficiary

If you are:

  1. The spouse of the deceased
  2. A minor child of the deceased
  3. Chronically ill
  4. Disabled, or
  5. NOT more than 10 years younger than the deceased

then you have two options. You can still take Option 1 and stretch out the IRA for 10 years with no RMDs. However, you also have what we will call Option 2. Option 2 is basically just applying the old Stretch IRA rules. You can start taking RMDs based on YOUR age. If you are very young, those can be very small, significantly smaller than the expected return on the investments in the account. In essence, the account can continue to grow, with tax and asset protection, for decades. The RMD for a 10-year-old is only about 1.4%.

 

Spousal Beneficiary

If you inherit an IRA from your spouse, you can take Option 1 or Option 2 if you like. However, you also have two more options:

  • Option 1: Inherited IRA, stretch it up to 10 years.
  • Option 2: Inherited IRA, start taking RMDs based on your own age.
  • Option 3: Become the owner of the IRA yourself (no longer an inherited IRA). It then becomes subject to the same rules as your own IRA.
  • Option 4: Transfer the IRA into your own IRA, 401(k), 403(b), or governmental 457(b). Again, the money then becomes subject to the same rules as contributions to the account you transferred the money into.

 

Which Option Should You Choose? 

Option 1 is best for those who want to spend all the money in the IRA in the next 10 years. These withdrawals are not subject to the 10% penalty for withdrawing prior to age 59 1/2. Plus, you can still leave part or all of it in there for up to a decade for additional tax- and asset-protected growth. This can also be a great option if you are over 72 and do not wish to take out RMDs for as long as possible. If you inherited the IRA at age 75, you could leave the money in there until age 85 without having to take any RMDs.

Option 2 is best for those who do not want to spend all the money in the IRA in the next 10 years but want to spend some of it and are still under 59 1/2. You are required to start taking RMDs, but you can take more out if you like without penalty. If you only take the RMDs, you can stretch those tax and asset protection benefits out for decades. This can also be a great move if you are older than your spouse and do not wish to take RMDs. If you are already 72+ but your spouse isn’t, you can delay the RMDs until your deceased spouse would have turned 72.

Option 3 is best for those who are young and have no desire to pull money out of the accounts for a long time. Be aware that this may be a bad option if you are currently doing Backdoor Roth IRAs and plan to continue doing them going forward. While inherited IRAs do not count toward the pro-rata calculation of the Backdoor Roth IRA process, it will count if it becomes your own IRA.

Option 4 is best for those who are still doing Backdoor Roth IRAs, those who want to simplify their accounts, or those who wish to roll the money into a retirement account with unique investments, such as the federal TSP or a self-directed individual 401(k).

You can also hedge your bets a bit. This is not an all or none decision. Some of the money can go into your own IRA/401(k), and some can go into an inherited IRA.

 

Successor Beneficiaries

Ever wondered what happens if you inherit an inherited IRA? You are then considered a “successor beneficiary” (not a contingent beneficiary, who inherits the IRA if the original beneficiary dies before or with the original owner). What happens then? One of three things:

  1. If the inherited IRA owner died prior to 2020, you have 10 years to withdraw the money from the IRA.
  2. If the inherited IRA owner died after 2019 and was an “eligible designated beneficiary,” you have 10 years to withdraw the money from the IRA.
  3. If the inherited IRA owner died after 2019 and was not an “eligible designated beneficiary,” you must withdraw the money within 10 years of the death of the original account owner.

 

The Bottom Line

Spouses have special privileges when it comes to IRAs. However, the rules surrounding these privileges can be complex. Make sure you understand them so you can optimize your own situation.

What do you think? What spouse-related IRA provisions have you taken advantage of in your life? Comment below!



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