Roth IRAs are a fantastic way to allow your investments to grow tax-free. However, in order to make contributions to a Roth IRA, you need what the IRS defines as “earned income.” It is vital to under how the IRS defines earned income and the special workaround for funding a spouse’s IRA who does not work.
While you don’t need a job to open a Roth IRA, you can only contribute earned income into the account. The only exception is if you are married and file jointly with a spouse who has sufficient earned income to fund your Roth IRA for you.
Do You Need a Job to Open a Roth IRA?
What Is Considered Earned ‘Income’ for Roth IRA?
Direct from the IRS website, they state that “…earned income includes all income from employment, but only if it is includable in gross income. Examples of earned income are…”
- Wages, salaries, and tips
- Taxable employee compensation (like bonuses or commissions)
- Net earnings from self-employment
- Combat zone compensation
Generally, this earned income is going to come from a W2 job, 1099 freelance, etc.
It is important to understand that since you may only contribute earned income, in order to max out your Roth IRA at $6,000 annually you would be required to make at least $6,000 for that year. So if you had $3,000 in earned income for that year, the maximum amount you could contribute into a Roth IRA would be $3,000.
The only way around this rule is to either commit tax fraud (not advised) or to have a working spouse who has extra income that can contribute to the non-working spouse’s Roth IRA.
Scholarships / Fellowships
One lesser-known form of earned income worth mentioning is through scholarships/fellowship stipends that are taxable. Since you do have to pay taxes on these amounts, the IRS considers it to qualify towards earned income.
What Is NOT Considered ‘Earned Income’ for Roth IRA?
Since Roth IRAs are designed for the worker, they have limits in place to prevent the rich from using the Roth IRA account for tax shelters. This means that the following income is not considered earned income, and as such cannot be used to fund a Roth IRA.
- Pensions / Annuities
- Welfare benefits
- Unemployment compensation
- Worker’s compensation benefits
- Social security benefits
- Child support
Spousal Roth IRAs
Despite the name of ‘Spousal IRAs’, these are not actual specific accounts, but rather the same normal Roth IRA accounts any individual can open.
However, there is a special law that exists for couples who choose to file their taxes jointly. Emphasis on the filing taxes jointly as if a couple chooses to file separately, this does not apply.
Imagine there is a husband who makes a minimum of $12,000 a year, married to an unemployed woman. As long as they choose to file jointly, the husband is able to max out his $6,000 annual contribution into his Roth IRA, and then go on to max out the wife’s Roth IRA with his extra income.
When Should you Begin Roth IRA Contributions?
Armed with a newfound understanding of who is eligible to contribute to a Roth IRA, the next natural question is when should you fund a Roth IRA? If you have read through 6 Steps to Build Wealth, you know the answer to this like the back of your hand. For those who haven’t, we will break things down for you.
While contributing to your Roth IRA is always a great idea, there are three boxes you should try and check before you begin Roth IRA contributions.
Step 1: Build Up A Sufficient Emergency Savings Fund:
If you have unexpected financial hardships, it will prove difficult to withdraw money from your Roth IRA without taking a hefty loss. For this reason, you should aim to have 3-6 months of expenses tucked away into a High Yield Savings Account (HYSA) as an Emergency Savings Fund just in case.
Step 2: Take Advantage of Employer Match:
If your current employer offers a 401(k), or any other tax-advantaged retirement account, discuss with your employer if they offer a match. If they do offer an employee match, contribute the minimum amount needed to receive the full benefit of the matching program.
Step 3: Pay Off High-Interest Debt (5%+):
If you have high-interest loans such as credit card debt, private student loans, bad car loans, etc. You should prioritize paying these down aggressively before contributing money towards your Roth IRA.
Once you have built up a healthy emergency savings fund, taken advantage of your employer match, and paid off high-interest debt, you can now begin funneling money towards your Roth IRA with the confidence that you can weather any financial storm that life may throw at you.