Hitting the jackpot with a big lottery or sweepstakes win is a dream that everyone shares, but when it happens to you, the reality of what to do with that money can be overwhelming. Being sensible, you could decide to deposit some of the money into an IRA account, but you may be unsure of what percentage to contribute. Annual IRA contributions are based on a maximum allowable amount, not on a percentage of your income.
If you are under age 50, the maximum you can contribute to any IRA is $5,000 per year. If you are over age 50, you are allowed to make a catch-up contribution of $1,000, bringing the total to $6,000 per year. If you are married and file a joint return, your spouse may also contribute to his own IRA, subject to the same limits.
Roth or Traditional?
Retirement savers have a choice between two different types of account that they can set up on their own: a Roth or traditional IRA. Both are suitable for you to deposit sweepstakes or gambling winnings into. A traditional IRA may provide an immediate income tax benefit because your contributions may be tax deductible. A Roth IRA provides no immediate tax benefit, but the withdrawals made at retirement age are completely tax free.
You may contribute the maximum amount to a traditional IRA if you are under age 70 under all circumstances. The tax deductibility of your contributions may be limited depending on your adjusted gross income and if you or a spouse are covered by a retirement plan at work. Roth contributions are not restricted based on employer-plan participation, but may be phased out or eliminated depending on your adjusted gross income. Even if you would normally be eligible to contribute or deduct contributions, winnings and other windfalls are added to your adjusted gross income and could cause you to exceed income guidelines for eligibility.
To contribute to any type of IRA, you must have income from compensation, or earned income. You may contribute the lower of your earned income or the allowable IRA contribution to an IRA account each year. Winnings from lotteries or a sweepstakes do not qualify as compensation, and you will not be able to contribute any amount to an IRA if the winnings are your only source of income.
If you are not eligible to make an IRA contribution in a year, or you wish to contribute more than what is allowed, you can stagger your contributions from winnings over multiple years. Open a taxable investment account and deposit the percentage of the winnings that you wish to contribute to a retirement account. When you are eligible for IRA contributions in the future, transfer money from the regular taxable account to the IRA account. This way you can preserve some of the tax benefits of an IRA.