One Income, Two Retirements

IRAs for nonworking spouses let you build your own nest egg -- and in many cases, the contribution will be tax-deductible

Spouses drop out of the workforce for all sorts of reasons -- to rear children, write a novel, or just get away from it all. Such noble pursuits have one serious drawback, however: Often, they mean leaving behind company-provided retirement-saving plans. Also, individual retirement accounts, 401(k) plans, and Social Security benefits are generally geared toward providing retirement income to people who earn salaries. Couples that include one working and one nonworking spouse face funding two retirements out of one income. And that challenge is magnified if something happens to the employed partner -- as was the case with many families affected by the September 11 terrorist attacks.

All of these are good reasons to plan ahead for every contingency. When it comes to retirement, that means creating and contributing to a spousal IRA -- starting right now. The spousal IRA allows a married spouse who files jointly to contribute $2,000 a year to both his and her IRAs, as long as the working spouse earns at least $4,000 a year. This type of IRA can be either a traditional plan funded with pretax dollars if the contributor is eligible or a Roth IRA funded with aftertax dollars.

CAN YOU DEDUCT?

  A retirement contribution of $2,000 annually for a nonworking spouse may not sound like much, but we've come a long way, baby. Thanks to the 1997 Taxpayer Relief Act, the contribution limit is up from a mere $250 five years ago. For tax year 2002, the cap -- whether for the main breadwinner or a nonworking spouse -- will increase to $3,000, then to $4,000 in 2005, and $5,000 in 2008.

Once you've decided to start a spousal IRA, the next step is to determine if you qualify to deduct your contribution for income tax purposes -- thus letting Uncle Sam help fund your contribution. There are two tests for deductibility: Whether the household breadwinner is covered by an employer-sponsored retirement plan and the size of that spouse's adjusted gross income.

"This always confuses people," says Mari Adam, a certified financial planner with an independent practice in Boca Raton, Fla. "If you aren't covered by an employer's plan, then you can deduct -- no matter what. I don't care how much money you make. You could be rich, and you can still deduct your contribution." And the nonworking spouse's contribution? "You bet."

ROTH FOR HER?

  If, on the other hand, your spouse is covered by a retirement plan at work, then his or her income level comes into play. Pay close attention, because you and your nonworking spouse can deduct different amounts depending on that income level. For tax year 2001, if your adjusted gross income is under $53,000, you can deduct the entire contribution to both IRAs. If AGI is between $53,000 and $63,000, the employed partner can deduct part of the contribution to his or her own IRA, plus the full amount to the spousal IRA.

Above $63,000, the primary wage earner can't deduct anything, but the two spouses, filing jointly, can take a full deduction for the spousal IRA until their adjusted gross income reaches $150,000. After that, the nonworking spouse's deduction dwindles until it finally phases out at $160,000.

Alternatively, you might want to consider a Roth IRA for your spouse. Again, the $160,000 income limit applies, but there's no deductibility for the contribution. Contributions to a Roth are made using dollars that have already been taxed, but you can start withdrawing the money tax-free after you turn 59 1/2.

PLUMPER CUSHION.

  Couples who feel they need the cash flow today will generally opt for a traditional IRA, which allows a tax deduction against current income. You pay tax on the amount your account has earned over the years only when you withdraw the money. The thinking is that in retirement, you'll probably be in a lower tax bracket than you were in when you made the contributions. Although you don't get a tax deduction on your current income with a Roth, you pay no tax when you withdraw money from your account in retirement.

Still, compared with the amount of money many working people are able to save through 401(k)s and other employer-sponsored plans, an IRA may not provide much of a cushion if something happens to your husband. If you're a stay-at-home spouse and worried about having enough to live on, in addition to your Roth or traditional IRA, you might also want to consider a taxable retirement savings account. Even though it will give you no tax benefits, it will be extra savings for your retirement and could well come in handy when neither you nor your spouse are working.

Whichever route you and your husband choose, "it's important for a nonworking spouse to build up assets in her own name," Adam says. "Too often, a woman quits her job, or doesn't work, and the couple fills up the husband's retirement to the max. She isn't using her job skills. Her work experience gets outdated. Not every marriage is happy and lasts forever, they get divorced -- and she's left with zippo. I see it all the time." Adam recommends funding the nonworking spouse's retirement along the way, rather than having to take a lump sum distribution in the event of divorce.

"ON THE PAYROLL."

  Broader options are available if you or your spouse is a small-business owner. One way to beef up the retirement savings of a nonworking spouse or a domestic partner is to hire the spouse as an employee and set up a SIMPLE retirement plan. A SIMPLE plan (Saving Incentive Match Plans for Employees) allows employees to contribute up to $6,000 pretax to an account that can then be matched up to 3% of salary by the employer.

This arrangement would let the spouse or partner save a much larger chunk of money than he or she would otherwise -- but the spouse would have to work for the business. "Most of my clients who own small businesses are doing more than the spousal IRA," says Doug Stives, a CPA and partner at Wiss & Co. in Red Bank, N.J.

"Typically, they put the spouse on the payroll -- she has to work, and you have to pay wages commensurate with her experience -- then she's eligible for a SIMPLE." You can have a SIMPLE even you work part-time. If you decide to go that route, you'll save yourself considerable domestic strife if you clearly define at the beginning what the spouse's duties are for the company and what schedule he or she works.

Saving for retirement isn't easy. It usually comes as an afterthought -- after the rent, the groceries, credit cards, car payments, and college saving. Like everyone else, one-income couples should balance spending and saving, but they also need to be mindful of the balance of assets between spouses. In the wake of September 11, it's clear: Couples should save for retirement in the name of both spouses to make the most of the available tax advantages -- and to provide an added measure of security in increasingly unpredictable times.

By Katie Starr

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