7 Things You May Not Know About IRAs: Maximize Your Retirement Strategy

As tax season approaches, many individuals are reviewing their financial strategies and looking for ways to optimize their retirement savings. Individual Retirement Accounts (IRAs) are a crucial component of retirement planning, yet many investors overlook some lesser-known strategies and tax benefits. Whether you’re a seasoned investor or just starting out, understanding the full potential of IRAs can help you maximize your savings and minimize tax liabilities. Here are seven things you may not know about IRAs that could enhance your retirement strategy.

1. A Nonworking Spouse Can Open and Contribute to an IRA

Retirement savings are not just for those with earned income. If one spouse earns income while the other does not, the nonworking spouse can still contribute to an IRA through a spousal IRA. This allows the couple to effectively double their IRA contributions, maximizing their long-term savings potential.

• For 2024, the annual IRA contribution limit is $7,000 per individual, or $8,000 if you’re age 50 or older.
• Contributions can be made to either a traditional IRA (which may provide a tax deduction) or a Roth IRA (which allows for tax-free withdrawals in retirement).
• If the working spouse is covered by an employer-sponsored plan, the deductibility of traditional IRA contributions may be subject to income limits.

2. You Can Contribute to an IRA Even If You Don’t Qualify for Tax Deductions

Many people assume that if they earn too much to qualify for a tax-deductible IRA contribution, they cannot contribute at all. This is not the case. If your income exceeds the limits for a deductible traditional IRA or a Roth IRA, you can still make non-deductible contributions to a traditional IRA.

While you won’t get an immediate tax deduction, your investments will still grow tax-deferred, which can be beneficial over time. Additionally, these non-deductible contributions can later be converted into a Roth IRA (see point #7 below), providing tax-free growth and withdrawals in retirement.

3. Alimony No Longer Counts as Taxable Compensation for IRA Contributions

Prior to the Tax Cuts and Jobs Act of 2017, individuals receiving alimony could use those payments as earned income to contribute to an IRA. However, for divorce or separation agreements finalized after January 1, 2019, alimony payments are no longer considered taxable income, which means they no longer count as earned income for IRA contribution purposes.

Those with agreements finalized before December 31, 2018, are grandfathered in, meaning their alimony still qualifies as earned income for IRA contributions.

4. Self-Employed or Freelancer? Save More with a SEP IRA

If you’re self-employed or earn income from freelancing, you have a powerful retirement savings option: the Simplified Employee Pension (SEP) IRA. A SEP IRA allows higher contribution limits compared to a traditional or Roth IRA, making it an excellent choice for entrepreneurs and small business owners.

• Self-employed individuals can contribute up to 25% of their net earnings to a SEP IRA.
• The contribution limit is significantly higher than traditional IRAs, making it an effective way to build retirement savings faster.
• Contributions may be tax-deductible, lowering your taxable income for the year.
• You have until the tax filing deadline (including extensions) to set up and contribute to a SEP IRA.

5. “Catch-Up” Contributions Help Those 50 or Older Save More

If you’re age 50 or older, the IRS allows you to make additional “catch-up” contributions to your IRA. For 2024, the catch-up contribution is an extra $1,000 per year, bringing the total contribution limit to $8,000 for those eligible.

• This provision helps individuals who may have started saving late or experienced financial setbacks.
• Over time, catch-up contributions can significantly increase your retirement savings. For example, an extra $1,000 per year for 20 years, assuming a 7% average return, could grow to nearly $44,000.

6. You Can Open a Roth IRA for Your Child

Starting retirement savings early provides a tremendous advantage, and children with earned income (from a part-time job, babysitting, mowing lawns, etc.) can open a Roth IRA. Since children generally fall into lower tax brackets, contributing to a Roth IRA makes sense because the contributions grow tax-free and can be withdrawn tax-free in retirement.

• Parents and grandparents can gift the contribution amount, allowing the child to keep their earnings while still funding the IRA.
• A custodial Roth IRA (such as the Fidelity Roth IRA for Kids) is managed by an adult until the child reaches the age of majority.
• The annual contribution limit for a child’s Roth IRA is $7,000 or their total earned income, whichever is less.
• A Roth IRA does not count toward college financial aid calculations, making it a great college savings alternative.

7. You Can Still Have a Roth IRA Even If You Exceed Income Limits

Many high-income earners mistakenly believe they cannot contribute to a Roth IRA. However, the Backdoor Roth IRA strategy allows individuals to convert a traditional IRA into a Roth IRA, regardless of income level.

• How it works: Make a non-deductible contribution to a traditional IRA and then convert it into a Roth IRA.
• If you have no other traditional IRA assets, this conversion may result in little to no tax liability.
• If you have other IRA assets, the IRS applies the pro-rata rule, meaning you could owe taxes on a portion of the converted amount.
• Consult a tax professional before executing a Backdoor Roth conversion to ensure you understand the tax implications.

Final Thoughts

IRAs are powerful tools for building a secure retirement, but many investors miss out on key opportunities to maximize their benefits. Whether it’s taking advantage of spousal IRAs, SEP IRAs, catch-up contributions, or Roth IRA conversions, understanding these nuances can help you make smarter financial decisions.

Now that you know these seven important IRA strategies, take a moment to review your own retirement plan. Are you maximizing your contributions? Have you considered a Roth IRA conversion or a spousal IRA? The sooner you leverage these IRA strategies, the better positioned you’ll be for a comfortable and financially secure retirement.

If you need further guidance, consult with a financial advisor or tax professional to tailor these strategies to your specific situation.