Does Compensatory Income Count Against Your Roth IRA?

by Jane Meggitt

To qualify to contribute to a Roth individual retirement account (IRA), an individual must have an adjusted gross income limit below a certain amount. Compensatory income, that which results from a lawsuit or similar legal settlement as compensation, is not taxed by the Internal Revenue Service (IRS) and does not count as part of the adjusted gross income (AGI) limit.

Roth IRAs

Unlike traditional IRAs, contributions to Roth IRAs are not tax-deductible. These contributions are made with post-tax income, so distributions are tax-free. As long as the account is open at least five years, Roth IRA account owners may take distributions at the age of 59 1/2. Unlike traditional IRAs, there is no mandatory age to take distributions, and as long as earning income, contributions may be made to the account past the age of 70 1/2.

Adjusted Gross Income

As of the time of publication, single taxpayers may make a Roth IRA contribution if the AGI is under $107,000. Single filers earning between $107,000 and $122,000 may make a partial contribution. Above that amount, single filers may not make a Roth IRA contribution but may contribute to a traditional IRA. If not covered by an employer-sponsored retirement plan, the contribution is deductible. Married couples filing jointly may both contribute to Roth IRAs if the adjusted gross income is under $169,000. Those earning between $169,000 and $179,000 may make partial contributions. Married couple earning above that amount may consider contributing to a traditional IRA.

Contributions

Taxpayers qualifying for Roth IRAs may contribute up to $5,000 annually as of the time of publication if under the age of 50. Those aged 50 and up may contribute up to $6,000 per year. These amounts assume the contributor makes at least that much in annual income. You cannot contribute more money to the account than you earn annually.

Compensatory Income

The IRS does not tax compensatory income received as damages, and this does not affect the Roth IRA income limits. This includes compensation received for injury or illness, either paid in one lump sum or periodically. Disability benefits received for income loss or earning capacity loss due to an accident under a no-fault automobile insurance policy also do not count. If you receive compensation for "permanent loss or loss of use of a part or function of your body, or for permanent disfigurement," it does not count for Roth IRA purposes. Such compensation is based only on the actual injury and not the lost work period.

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