IRA & Alimony
You are allowed to contribute amounts you receive as alimony to an individual retirement account (IRA) despite the Internal Revenue Service's general requirement that IRA owners use earned income to fund their accounts. However, you must be careful not to make an IRA contribution that exceeds amounts you received from IRS-approved sources in a given year.
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Function
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Congress designed IRAs to give working Americans a tax break to invest for retirement. As such, the government wanted to prevent people from funding IRAs with investment or inherited income. Thus, it devised a list of income sources that owners may contribute to their IRAs; among them, income from a job, be it salary, wages, commissions or tips. The IRS also allows IRA owners to contribute military combat pay, military differential pay and alimony. The IRS calls amounts you receive from these sources "compensation."
Significance
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At first glance, it would not seem that alimony is, in fact, compensation equal to that a worker earns at a job. However, Congress has consistently passed legislation that makes it easier for a non- or low-earning spouse to contribute to an IRA as long as a couple's joint income is large enough to cover the cost of their total contributions in a given year. This is called a spousal IRA contribution. Spousal IRA rules acknowledge that couples plan for retirement together and if a spouse leaves the workforce, she should not cease saving for retirement. Allowing alimony contributions extends this logic to low-earning spouses who divorce their partners.
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IRA Contribution Limits
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Each year, the IRS determines the total amount you are allowed to contribute to your Roth and traditional IRAs. In 2010, the limit was $5,000 if you are under 50 and $6,000 if you are older. Despite this limit, your IRA contribution cannot exceed your total compensation. For instance, if you were 45 in 2010 and received $2,000 in alimony and earned $2,000 at a part-time job but had no other compensation income, your total IRA contributions could not exceed $4,000.
Warning
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If your IRA contribution exceeds either the general limit or your total compensation, whichever applies, the IRS charges a 6 percent excise tax on amounts that remain in your account after the end of the tax year. If you accidentally contribute too much, you must withdraw the excess amount plus any earnings that portion of your contribution earned to avoid the penalty. The IRS will continue charging you 6 percent each year the excess contribution remains in the account.
Benefits
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Though IRA rules can be complicated, they provide a significant tax shelter for your retirement assets. If you choose to open a traditional IRA, you can deduct your contribution and delay paying taxes on your asset earnings until you make withdraws from the account. Roth IRAs allow you to take tax-free withdrawals beginning the year you turn 59 1/2. Providing yourself with a tax-sheltered nest egg is particularly important if you signed away your claim to your share of a partner's 401k or pension benefits.
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