Reality Check on IRAs

August 14, 2014 4:00 PM
By Brian Dobbis

Misconceptions about eligibility may explain why only 15% of qualified individuals have IRAs. 


Anyone who has compensation (i.e., earned income, as defined by the IRS) is eligible to fund a traditional IRA or a Roth IRA. The sole exception to the earned-income requirement is a spousal IRA, which is funded by a working spouse on behalf of a spouse who has little or no income. Spousal IRA rules permit a working spouse to fund an IRA in the name of the nonworking spouse.

Although it is easy to become eligible to contribute, only an estimated 15% of eligible taxpayers made an IRA contribution in tax-year 2012, according to the Investment Company Institute. The low participation rate can partly be attributed to investors’ misconceptions about eligibility and compensation

Let’s review what’s considered “earned income” for IRS purposes regarding IRA contributions. We then will look at some potential eligibility mishaps.

The IRS considers compensation (earned income) to include wages, salaries, tips, professional fees, bonuses, other taxable employee pay, and other amounts received for providing personal services; it also includes commissions and nontaxable combat pay. If you are self-employed, compensation is your net earnings from self-employment. Different rules apply to SEP and SIMPLE accounts. 

Source: Internal Revenue Service.

Tip: Note that individuals can fully contribute to both their 401(k) ($17,500 plus $5,000 catch-up) and an IRA ($5,500 plus $1,000 catch-up).  In 2014, this amounts to $23,000, or $29,000 for those individuals aged 50 and older.

Traditional IRA Eligibility:

  1. You received earned income during the year, and
  2. You did not attain age 70½ by the end of the year.  If you are 70½ or older at the end of this year, you are prohibited from making a traditional IRA contribution for 2014 and after.

If you have earned income, but are older than 70½, all is not lost. You may be eligible to make Roth IRA contributions.

Roth IRA Eligibility:

  1. You received  earned income during the year, and
  2. You satisfy the statutory income thresholds. (See the Eligibility tab on the Roth IRA page for a breakdown.)

Unlike traditional IRAs, Roth accounts do not impose an age cap.  In other words, individuals older than 70½ who satisfy the earnings test are eligible to fund a Roth IRA.

Advisor Action Steps

  1. Contact all clients who have “earned income” and make them aware of their IRA eligibility.
  2. Discuss Roth IRAs versus traditional IRAs.
  3. Let clients know that participation in employer-sponsored plans, such as 401(k), 403(b), 457(b), SIMPLE, and SEP, does not affect IRA eligibility. However, participation may affect whether or not IRA contributions are deductible.

Do you have any tips that might help advisors help their clients save for retirement? Please join the investment conversation.

Brian Dobbis, QPFC, QPA, QKA, TGPC, serves as Lord Abbett’s IRA Product Manager.


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"Contact all clients who have earned income and make them aware of their IRA eligibility".
Does Lord Abbett have anything available to send to clients?
Great info. There is a difference between contributions and deductibility, It is my understanding that a participant in a 401(k) Plan cannot deduct contributions to a Traditional IRA. Is that your understanding as well?
An individual that participates in a 401(k) or similar plan still could be eligible to make deductible contributions to a Traditional IRA. Deductibility is dependent on tax filing status and household income; based on Modified Adjusted Gross Income (MAGI). Click here for eligibility:
John, thank you for joining the conversation on The Road to Retirement. We have a number of postcards in our “Documents and Literature” section of our site−−
−− that provide information for your clients.