The Roth IRA is a powerful retirement savings tool. The combination of tax-free growth and tax-free withdrawals, combined with the ability to wait indefinitely before being forced to take a minimum required distribution, can be a powerful wealth generator to those in higher tax brackets in retirement and with long time horizons. There is, however, a catch: You must have earned income during the tax year to contribute to the Roth IRA.
Roth IRA Eligibility
If you are single or a head of household, or you lived apart from your spouse all year and you file separately, you must have a modified adjusted gross income of less than $120,000 to contribute, as of publication. If you are married,your income must be less than $177,000. If you are married and file separately, but lived with your spouse during the year, you must have earned less than $10,000. However, you cannot contribute more than your earned income during the year.
Earned income consists of earnings from wages, commissions and other compensation. It does not include pension or investment income. Generally, you must have earned taxable income during the year. However, uniformed service members earning tax-free income while deployed in a combat zone are exempt from this rule and may contribute to a Roth IRA. If all you have during the year is pension and investment income, you may not contribute to a Roth IRA.
A working person my make contributions to a Roth IRA on his spouse's behalf, provided he has enough earned income to cover the contribution. For example, if you have a married couple with one spouse working as a homemaker, and the other spouse is working and earning an income within the Roth IRA income limits, the working spouse may contribute up to $10,000 total during the year, or $5,000 each. If either partner is over age 50, that contribution limit is increased by $1,000 per partner over age 50.
If you have significant unearned income from investments, pensions or other nontaxable sources, you may consider purchasing or increasing funding of a permanent life insurance policy. Cash value built up in permanent life insurance policies is also tax deferred, and if the policy was structured properly, you can withdraw dividends tax-free, as well as borrow against the remainder of the cash surrender value, tax-free, in retirement. The net result is very similar to the tax treatment of Roth IRA plans.