I understand you must have earned income to qualify for a conventional or Roth IRA. Is that to say the funds used to open an IRA must come from your earned income somehow? Or, is it a simple matter of a checking a box: Can you show you have an earned income? (I ask because, yes I have earned income, but the funds I wish to invest were unearned. Is that a problem?)
Furthermore, what if you are unemployed during any time in the tax year and your earned income lapses? Say you still have some money to set aside in an IRA. Can you still contribute to your IRA if you’ve received earned income at any part of the year?
I am assuming these are simple questions with simple answers, but if it more complex than can be stated here, maybe some recommended links may help explain. Thanks.
You can contribute to an IRA up to the lesser of the two amounts, either your limit based on age, $6,000/yr or $7,000 if older than fifty or your taxable compensation for the year. You don’t have to put the earned money in, it can come from other sources, but the money put in can not exceed the amount earned.
The money you put into an IRA can come from anywhere as long as you don’t exceed the contribution limits. In 2020, the limit for most people was $6000, or their earned income for the year (Retirement Topics - IRA Contribution Limits | Internal Revenue Service). For example, a 17 year old earns $5000 mowing lawns in the summer, which she reports as self employment income. Her parent (or anyone, for that matter) may give her up to $5000 to put in an IRA. It doesn’t matter that she didn’t work all year, only the amount she earned.
If you show wages from a job or self-employment income on your 1040, then you can have a IRA. It doesn’t matter if you only made $6000 from a job that year and then made $1,000,000 from stock sales, you can contribute the full amount.
Your first part was correct but this snip isn’t quite. Simplifying a bit to avoid drowning the message in the details …
The ability to contribute to a Roth IRA phases out if your MAGI, which would include the profit on the stock sales, exceeds a threshold. For single people the threshold is about $150K and for married it’s about $200K. MAGI isn’t quite the same as straight income, but the point remains that a million in profit on stock sale would blow those thresholds out of the water and preclude a Roth contribution.
For a traditional IRA there is no such threshold beyond which you can’t contribute. But there are thresholds beyond which you cannot deduct your contribution from current taxes. At least that’s true provided you or your spouse have an employer retirement plan such as a 401K or traditional pension. Again simplifying mightily, if your MAGI as a single person is above about $70K, you can contribute but you can’t deduct. For married folks the deductibility threshold is about $110K. So our hypothetical taxpayer with a million in stock profits would also be unable to make a deductible contribution. At least if he had a job with a retirement plan attached. If no retirement plan, these thresholds go away.
Though you can convert a IRA to a Roth IRA, and if one does not make much in that year, and thus own little to no taxes, it may be a good time to do so as you would have to pay the tax on the conversion.
Small addition, which probably doesn’t apply for most people.
I live outside of the United States, and do not get a W-2 or 1099 for my earned income. As I am an American, I can still contribute to a traditional IRA and deduct the contribution based on the earned income reported to the I.R.S., subject to the same limits.
It’s a bit more complicated, but that’s why I have an accountant who knows the rules a lot better than me.