[Editor's Note: Nearly two years into the pandemic, ask yourself this question: Isn’t it time to invest in yourself so you can continue to invest in your patients? Don’t let pandemic-induced burnout stop you from enjoying a meaningful career or slow down your journey to financial freedom! Join like-minded individuals for The Physician Wellness and Financial Literacy Hybrid Conference February 9-12, 2022 in sunny Phoenix. You are worth the investment!]
By Dr. James M. Dahle, WCI Founder
There is a lot of confusion about spousal IRAs out there. I'm going to try to clear up as much of it as possible using a Q&A format.
What Is a Spousal IRA?
There is actually no such thing. A spousal IRA is just an IRA. It can be a traditional (tax-deferred) IRA or a Roth (tax-free) IRA. It has the exact same contribution limits as any other IRA ($6,000 per year, $7,000 if 50+ for 2021). It can be converted to a Roth IRA, it can be rolled over into a 401(k), it can be stretched by your heirs for up to 10 years. It's just an IRA. The deadline for contributions is the day you file your taxes, generally April 15 of the next year, but it can be extended through October 15 of the next year if you file an extension. Once the contribution is made and the deduction (if any) is taken, a spousal IRA acts no differently at all than any other IRA.
So Why Call It a Spousal IRA?
The one unique thing about a spousal IRA is that you don't have to have any personal earned income to make the contribution. It should really be called the “stay-at-home-spouse” IRA or something, because that's who it is for. As long as you file your taxes Married Filing Jointly (MFJ) and the working spouse made enough earned income to cover their own IRA contribution and your IRA contribution, the non-working spouse can still contribute to an IRA without any earned income.
Can I Do a Spousal IRA for My Domestic Partner?
Which part of “spouse” is hard for you to understand? No. You must be legally married by December 31 of the year for which you are making an IRA contribution.
Do We Just Combine Our IRAs?
No. IRA stands for INDIVIDUAL Retirement Arrangement. They are always individually owned. They are never co-owned. Your spouse can be your beneficiary, but they cannot own or co-own your IRA (unless you die). You don't make a $12,000 contribution to an IRA, you make a $6,000 (2021, under 50) contribution to each IRA.
What Are the Spousal IRA Contribution Limits?
The answer to this question depends on three things:
- How much income the couple earned together (technically a modified adjusted gross income or MAGI)
- The age of the spouse
- How the couple files their taxes
If under 50, the maximum spousal IRA contribution is the lesser of $6,000 (2021) or the total amount of earned income (wages, tips, salaries, commissions, nontaxable combat pay, and self-employment income) by the couple minus the non-spousal IRA (and/or Roth IRA) contribution. If 50+, the maximum is $7,000 or the total amount of earned income by the couple minus the non-spousal IRA contribution. Unlike a traditional IRA contribution, where there is no limitation for high-earners, the ability to make Roth IRA contributions is phased out over a MAGI range of $198,000-$208,000 (2021, MFJ). If the couple files their taxes as Married Filing Separately (MFS) instead of Married Filing Jointly (MFJ), no spousal IRA contribution can be made.
How Much of a Traditional Spousal IRA Contribution Can Be Deducted?
The answer to this question depends on a couple of things:
- Whether the working spouse is “covered by a retirement plan” through their employer (i.e. a contribution was made to a defined contribution or defined benefit plan during the calendar year)
- How much income the couple earned together
If neither spouse is covered by a retirement plan, then both spouses may fully deduct contributions to their IRAs no matter what their income. If one spouse is covered, the ability for the spouse without a retirement plan to deduct their contribution is phased out between a MAGI of $196,000-$206,000 (2021, Married Filing Jointly). See the chart below from IRS Pub 590A.
How Is MAGI Calculated?
The calculation to determine Modified Adjusted Gross Income (MAGI) begins with the Adjusted Gross Income (AGI). Your AGI is your total income minus all of your “above the line” deductions, such as retirement account contributions, Health Savings Account (HSA) contribution, deductible part of self-employment taxes, student loan interest deductions, tuition and fees deductions, educator expense deductions, and certain other moving and business expenses. It is calculated on your Form 1040 (see line 11) and especially Part II of Schedule 1 of Form 1040. The AGI is then “modified” by adding back in three types of income (which incidentally, most people contributing to IRAs don't have):
- Excluded foreign income
- Nontaxable Social Security benefits
- Tax-exempt interest (think muni bonds)
What Should We Be Thinking About If We File Our Taxes MFS?
Sometimes spouses file their taxes Married Filing Separately (MFS). In the White Coat Investor Community, the main reason people do this is to “hide” the income of a high-earning spouse from the calculations that the Department of Education uses to determine student loan payments in the Income Driven Repayment (IDR) programs like Income Based Repayment (IBR) and Pay As You Earn (PAYE). Note that the “file MFS to lower payments” trick doesn't work in the Revised Pay As You Earn (REPAYE) program as the income of both spouses is always counted in that program.
Savvy (or, some might argue, unethical) borrowers first file their taxes MFS to lower their required IDR payments (and potentially increase the amount of money forgiven via the tax-free PSLF [10 years of payments while working full-time for a nonprofit], the taxable IBR [25 years of payments], or the taxable PAYE [20 years of payments] forgiveness programs). While this usually lowers the payments due, it also usually increases the tax bill, so these borrowers subsequently refile their taxes a year later as Married Filing Jointly (MFJ) and get those taxes back. Since the Department of Education and the Department of the Treasury don't talk to each other, this essentially lets these investors have their cake and eat it too.
However, filing your taxes MFS can have a serious impact on IRA contributions. For example, you cannot make a spousal IRA (neither traditional nor Roth) contribution when filing taxes MFS (and the “savvy” borrowers described above cannot make an IRA contribution later when they refile their taxes MFJ). In addition to this, the income limit on direct Roth IRA contributions is very different for those filing MFS than for those filing MFJ. Remember, the ability to contribute directly to a Roth IRA is phased out over a MAGI range of $198,000-$208,000 (2021) if you are filing MFJ. But if you file MFS, that phaseout range drops dramatically.
That phaseout range also depends, believe it or not, on whether you are physically living with your spouse at any point during the calendar year for which you are making the contribution. If you live together (even for a day) during the year, your ability to contribute directly to a Roth IRA is phased out between a MAGI of $0 and $10,000. In essence, this means if you are filing MFS and living together, you cannot make a full direct Roth IRA contribution. However, if you live separately for the entire year, that phaseout range occurs between a MAGI of $125,000-$140,000 (2021). This rule essentially means that those who file MFS typically need to do their Roth IRA contributions indirectly through the Backdoor Roth IRA process, just like high earners, at least for the low-earning spouse. Roth IRA contributions are also limited by MAGI on the lower end. Since you cannot do spousal IRA contributions when you file MFS, the maximum contribution in 2021 is the lesser of your own income or $6,000 ($7,000 if 50+).
How Does the Backdoor Roth IRA Process Work with a Spousal Roth IRA?
As noted above, if you file MFS, you cannot do a Spousal traditional or Roth IRA contribution. But the spouse can still contribute to a Roth IRA via the Backdoor Roth IRA process using their own income. If you file MFJ, the Backdoor Roth IRA process works as it does for any other person or couple. A Spousal IRA contribution is made to a traditional IRA. It is subsequently converted to a Roth IRA. The pro-rata rule will apply, so be sure to either convert or transfer into a 401(k) or 403(b) any traditional, rollover, SIMPLE, or SEP IRAs prior to December 31 of the year in which you do the conversion step so you can avoid pro-rata. Every Backdoor Roth IRA question you can possibly think of has been asked and answered multiple times in this Backdoor Roth IRA Tutorial post and in the 2500+ comments below it.
What Else Is Unique About the IRAs of Spouses?
Another unique aspect of the IRA of your spouse has nothing to do with “Spousal IRAs” since there is no difference in a spousal IRA and any other IRA once the contribution and deduction have been determined. This occurs at death. Normally when you inherit an IRA, you must withdraw the contents of that IRA within 10 years of the death of its owner. This is the “New Stretch IRA” that still allows you to stretch that tax-protected growth out for a decade. However, if you inherited the IRA from your spouse, you have three options:
- You can treat it like any other inherited IRA and withdraw the money over 10 years.
- You can combine it with your own IRA and it will then become subject to the withdrawal rules that apply to your IRA.
- You can stretch it according to the old Stretch IRA rules. These rules allowed you to stretch the IRA out over the rest of your life, taking out only the required minimum distribution each year.
This third option can be very useful to someone who is still well below age 59 1/2, allowing them to tap the IRA early and penalty-free but still not have to take it all out within 10 years.
Spousal IRA rules are designed to not penalize families with a stay-at-home parent or a homemaker spouse. However, they can be complicated, so be sure you understand the rules very carefully before using one—and especially before filing your taxes MFS.
What do you think? Have you made spousal IRA contributions? Why or why not? Comment below!