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George F. Bearup, J.D. Senior Legal Trust Advisor

4-Oct-21

What Constitutes Eligible Compensation for IRA Contributions?

Take-Away: With call the peculiar rules in 2020, like COVID related distributions and enhanced unemployment compensation benefits paid to millions, there is some confusion with regard to what is compensation for purposes of an IRA contribution. Sadly, unemployment compensation does not constitute compensation which can be used to fund an IRA.

Background:  In order to be eligible to make a contribution to an IRA, either to a traditional IRA or to a Roth IRA, the individual must have earned compensation. However, not all sources of financial support constitute compensation for purposes of making an IRA contribution.

Eligible Compensation: The financial sources that constitute compensation for purposes of making an IRA contribution are many. They include the following:

  • Salaries, wages, tips, and bonuses
  • Earned income from self-employment
  • Royalties
  • Commissions
  • Taxable alimony; (the tax consequences of many alimony or spousal support payments changed with the 2017 Tax Act, so the not all alimony payments received by an individual are taxable)
  • Taxable non-tuition  fellowship and stipend payments [new under the SECURE Act]
  • Difficulty-of-care payments to foster care workers [new under the SECURE Act]

Ineligible Sources for IRA Contributions: The following is an abbreviated list of sources of financial support or resources that are not eligible for IRA contributions:

  • Unemployment compensation benefits
  • Interest income
  • Dividends
  • Rental income
  • Capital gains from the sale of property
  • Deferred compensation
  • Pension, profit sharing or IRA distributions [including COVID-related distributions in 2020]
  • Life insurance proceeds
  • Disability insurance benefits
  • Child support
  • Social Security retirement, i.e. Old Age, benefits

Conclusion: The receipt of unemployment benefits and COVID-related distributions in 2020 will not completely disqualify an individual from making an IRA contribution for 2020, so long as the individual had other sources of compensation in 2020 from which IRA contributions can be made.