Funding an IRA: What Is and Is Not Considered Compensation | Lord Abbett
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Retirement Perspectives

The new tax law deems alimony payments as tax-free income, so it no longer qualifies as earned income and cannot be used to fund an individual retirement account.

You may be aware of what is and is not considered compensation to fund an individual retirement account (IRA). However, one provision of the Tax Cut and Jobs Act (TCJA) of 2017 that has received little press is alimony payments and how those payments affect IRAs and other retirement plans.

For divorce agreements beginning on January 1, 2019, alimony will no longer be deductible by the payor and instead will be tax-free income to the recipient. This means that alimony no longer qualifies as earned income and cannot be used to fund an IRA. This is significant, as it changes the alimony tax law that has been in effect for more than 70 years.

As you may recall, the TCJA made significant changes to both individual and corporate taxation. Along with tax brackets being changed, deductions have been limited and some deductions have been eliminated. Education and retirement accounts were affected too.

Under the prior tax law, alimony was taxable income to the recipient (generally lower income) and tax deductible to the individual paying the alimony (generally higher income) without itemizing (above-the-line deduction).

The new tax treatment will apply to those divorce agreements that are adopted on or after January 1, 2019. The new provision will also apply to prior agreements that are modified in 2019 and going forward. For those agreements adopted on December 31, 2018 or earlier, the “old” tax rules remain in effect.

Any individual whose only income in 2018 was from alimony payment would be deemed to have compensation for the purposes of contribution to an IRA. Thus, they can make a 2018 IRA contribution until April 15, 2019.

How does the new alimony tax law affect IRAs?

Having reportable compensation is a requirement for IRA eligibility (traditional or Roth).  Historically, alimony payments were deemed earned income for the spousal recipient, thus making the spouse eligible to make an IRA contribution even if they had no other source of earned income. The new rules, however, deem alimony payments as tax-free income, so it no longer qualifies as earned and cannot be used to fund an IRA.

What is and isn’t compensation for IRA purposes?

According to the Investment Company Institute, only 11 percent of U.S. households contributed to traditional or Roth IRAs in 2017, and very few eligible households made catch-up contributions to traditional IRAs or Roth IRAs.

A primary reason why more investors don't fund an IRA is due to common misconceptions regarding eligibility. There’s also confusion about which types of compensation can be counted to contribute to an IRA. Simply stated, most taxpayers are eligible to contribute to an IRA —again, compensation (earned income) is all that is needed. The sole exception to the earned income requirement is the spousal IRA, whereby the working spouse funds an IRA on behalf of the nonworking spouse.

Compensation for the purposes of funding an IRA includes: salary, wages, commissions, income from self-employment, and nontaxable combat pay.

It does not include: earnings and profits from property (rental income); income from interest, dividends, pensions, or annuities; deferred compensation; and Social Security.

Below are the complete eligibility requirements for contributing to a traditional or Roth IRA.

Traditional IRA

  • Received earned income during the year and
  • Did not reach the age of 70½ by the end of the year. Individuals who are 70½ or older at the end of this year are prohibited from making a traditional IRA contribution.

This time of the year, “tax season,” is traditionally the time of the year when a majority of IRA contributions are made. Contributions to a traditional IRA can be made with pretax and/or aftertax dollars, which leads to the inevitable question of what determines the deductibility of traditional IRA contributions.  See my article “Traditional IRAs—How to Determine if Contributions are Deductible.”

Roth IRA

  • Received earned income during the year and
  • Satisfy statutory income test

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


To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.


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