A spousal IRA is an investment strategy used by married couples to save for retirement. There is no separate type of individual retirement account called a â€śspousal IRAâ€ť â€” rather, itâ€™s just a traditional IRA for a married person who isnâ€™t earning an income. IRS rules allow spouses who arenâ€™t earning income, for whatever reason, to still use the tax advantages of saving and investing money in an IRA to accumulate a nest egg for retirement.
The IRS requires individuals to report annual income in order to fund an IRA â€” with the exception of a spouse who isnâ€™t earning an income, but is married to someone who is. If both partners in the marriage file taxes jointly, the IRS lets each partner have their own IRA. Married couples who file taxes separately are not eligible for the spousal IRAs approach.
According to Janice M. Cackowski, a financial advisor with providence Wealth Partners in Ohio, the IRS looks at married couples who file jointly as one entity, and their combined income as one figure, so spousal IRAs allow them to put away twice as much.
â€śSpousal IRAs are terrific tools when one spouse is employed and the other is not,â€ť said Cackowski. â€śIt allows the spouse who is earning wages to deposit them an IRA for the benefit of the non-working spouse, essentially allowing each spouse to maximize their retirement savings.â€ť
Like any other IRA, married people making use of a spousal IRA strategy contribute funds to their separate accounts and invest the funds in stocks, bonds, CDs and other assets. Interest accumulates over the years, and the account grows either tax-free or tax-deferred (more on this in a bit).
For example, if you contribute $6,000 a year to your IRA starting at age 30 until you retire at age 65, the sum would grow to more than $700,000, assuming a 6% annual rate of return. This figure doesnâ€™t account for taxes (so itâ€™s not entirely exact), but it does show how the power of compound interest can work in your favor over time.
Your spousal IRA can be either a Traditional IRA or a Roth IRA. The rules and contribution limits for spousal IRAs are no different than conventional versions of either account. Remember, the difference between a Roth IRA and a Traditional IRA comes down to when you can reap the tax benefits of each option, and Traditional IRAs may provide tax deduction benefits.
Which should you choose? In general, if youâ€™re in a lower tax bracket now than you expect to be when you retire, then a Roth IRA may be more beneficial, as you may save money on taxes down the road. This decision is unique in each situation.
For 2020, the annual contribution limits for both Traditional IRAs and Roth IRAs is $6,000, or $7,000 if youâ€™re 50 or older. This is the core benefit of a spousal IRA: A married couple can potentially sock away a total of $12,000 into their IRAs.
There is no income threshold for contributing to a traditional IRA, while the limit for contributing to Roth IRAs is $206,000 for married couples filing jointly. Also, In addition, for both Roth IRAs and Traditional IRAs, the married couple must have taxable income that is equal to or greater than the total amount contributed to their IRAs.
Couples can deduct their contributions to a Traditional IRA from their taxes, depending on two factors. The income tax deduction is reduced or eliminated entirely depending on the coupleâ€™s total income, or the earning spouseâ€™s participation in an employer-sponsored retirement plan.
If the spouse who works is covered by their employerâ€™s retirement plan, the Traditional IRA income tax deduction is phased out when the coupleâ€™s income falls between $104,000 and $124,000. Incomes above $124,000 get no tax deduction.
However, if the spouse does not participate in an employer-sponsored retirement plan, the deduction phases out at an income level of $196,000, and is eliminated after income hits $206,000. There are also tax credits available â€” the Saverâ€™s Credit â€” for married couples filing jointly who earn less than $65,000 a year.
Because IRA funds are intended for use in retirement, withdrawing them before that time often comes with a penalty. For traditional IRAs, thereâ€™s a 10% penalty if you withdraw funds before age 59 Â˝, and you also must pay taxes on the money you withdraw. For Roth IRAs, you can withdraw the funds you contributed at any time penalty free, since you already paid taxes on them up front, but youâ€™ll pay a 10% penalty on any earnings if you with withdraw them sooner than five years after the account was opened or before age 59 Â˝ (whichever is longer).
For both traditional and Roth IRAs, there are some exceptions to early withdrawal penalties for things including death, disabilities and a first-time home purchase.
Any family with a non-working spouse and disposal income for long-term savings that is looking to increase their retirement nest egg should consider a spousal IRA as a potential option.
According to Michelle Buonincontri, an Arizona-based certified financial planner and certified divorce financial analyst, spousal IRAs help protect the non-working spouse in the case their happily ever after doesnâ€™t end quite so happily.
â€śLetâ€™s face it, with 50% or more of first marriages ending in divorce, spousal IRAs are a great way to level the playing field by having retirement assets in the name of the spouse that does not have access to a retirement plan if a couple ever find themselves in a divorce situation,â€ť she said.
Although retirement assets accumulated during the marriage are usually considered marital assets, Buonincontri suggested that â€śfolks seem less emotional about letting the other spouse keep accounts titled in their own name and less tense during the marital settlement negotiation process.â€ť
This doesnâ€™t mean contributing to a spousal IRA is right for every couple, however. While spousal IRAs are generally a positive investment, people need to take a hard look at their financial situation to make sure funds wonâ€™t be needed elsewhere.
Diane Pearson, a certified financial planner with Pearson Financial Planning in Pittsburgh, Penn., noted that a spousal IRA isnâ€™t always the first move couples should make with disposable income.
She advised that couples should build their emergency fund and general savings before opting for a spousal IRA. Savers donâ€™t want to set themselves up for additional taxes or early withdrawal tax penalties if they end up needing to pull funds out of an IRA to pay for near-term emergencies or a childâ€™s education before age 59 1/2.
â€śEvery situation is obviously different, but if an employer is offering the working spouse a match to a qualified retirement plan, and the individual instead decides to use their income to fund their non-working spouseâ€™s IRA, they may be missing out on the employerâ€™s matching contribution,â€ť said Pearson.
As we noted in the introduction, a spousal IRA is a strategy, not a distinct type of individual retirement account. Whether you choose to set up your spousal IRA as a Traditional IRA or a Roth IRA, you can do so through most banks, brokerage and wealth management firms, as well as robo-advisors.
How hands-on you want to be when it comes to managing your IRA will help you decide which route to go. While some providers will do all the work for you, youâ€™ll pay for that help in the form of management fees, other brokers give you complete control over your portfolio and you save on fees.