Establishing an IRA

Almost anyone with earned income can establish and contribute to a traditional Individual Retirement Account. Employees and self-employed persons can open IRAs for themselves, even if they already participate in tax-qualified, employer-sponsored plans. Participants in governmental plans also may open an IRA. An individual may open more than one IRA, as long as he or she does not exceed the annual contribution limits.

There is no age limit for contributing to a traditional IRA — the SECURE Act of 2019 eliminated the prior age 70½ cutoff. As a result, individuals of any age with earned income may contribute to a traditional IRA. Children are eligible to open IRAs if they earn compensation from after-school jobs or summer employment. Retired persons also may set up IRAs as long as they receive earned compensation (part-time jobs, consulting fees, etc.).

In the case of a married couple, if both spouses are employed, each spouse may set up his or her own IRA and contribute up to the annual limit. If only one spouse works, the employed spouse can set up a “spousal IRA” for a non-working spouse. Spouses may not open a joint IRA account. A “spousal IRA” is essentially two separate IRA accounts, each subject to the annual contribution limits.

In order to establish or contribute to an IRA, a person must receive earned income during the year. This includes wages, salaries, professional fees, and other amounts received for personal services. Earned compensation also includes sales commissions, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, as well as tips and bonuses. Taxable alimony or separate maintenance payments may also count as earned income for IRA purposes — but only under divorce decrees executed on or before December 31, 2018. Under the Tax Cuts and Jobs Act of 2017 (TCJA), alimony paid under post-2018 agreements is no longer taxable to the recipient and therefore does not qualify as compensation for IRA contribution purposes.

Earned income also includes compensation received by self-employed persons from a trade or business in which the individual renders income-producing services. Mere ownership of a business is not enough — the self-employed individual must actually “work” at the business. A self-employed person’s IRA contribution is based on his or her income after retirement plan contributions have been deducted.

For persons who are active partners in a partnership and who provide income-producing services to the partnership, earned compensation includes the active partner’s share of partnership income. Partnership income is not considered earned compensation for IRA purposes if a partner merely invests in the business and does not provide services to the partnership.

Earned income does not include return or profits from property, such as rent, dividends, or interest. Also excluded are disability payments, foreign income, and other amounts not includible in the taxpayer’s gross income. Compensation for IRA purposes does not include deferred incentives such as stock options or stock appreciation rights, pension or annuity payments, or other forms of deferred compensation. The IRS disallows IRA deductions when the taxpayer cannot prove the receipt of earned compensation.