Is Alimony Considered Earned Income for IRA Contributions?
Whether alimony qualifies as compensation for an IRA contribution depends on the timing of your divorce agreement and its resulting tax implications.
The ability to contribute to an Individual Retirement Arrangement (IRA) depends on having what the Internal Revenue Service (IRS) defines as compensation. Whether alimony payments meet this definition hinges on a specific date: when the divorce or separation agreement was finalized. This detail determines if those payments are considered taxable income and, consequently, eligible for IRA contributions.
Defining Compensation for IRA Contributions
To contribute to an IRA, an individual must have compensation. The IRS has a clear definition of what this includes, which is primarily income earned from working. Common examples of qualifying compensation are wages, salaries, tips, and commissions reported on a Form W-2. Net earnings from self-employment also count toward this total.
Certain types of income do not qualify as compensation for the purpose of making IRA contributions. These non-qualifying sources include interest and dividend income from investments, pension or annuity payments, and income generated from rental properties.
The Alimony Rule and Divorce Dates
The rules surrounding alimony and IRA contributions were fundamentally altered by the Tax Cuts and Jobs Act of 2017 (TCJA). The determining factor is the execution date of the divorce or separation instrument.
For any divorce or separation agreement executed on or before December 31, 2018, the old rules still apply. Alimony received is considered taxable income to the recipient. Because it is taxable, the IRS also classifies it as compensation for the purpose of making IRA contributions.
Under the changes brought by the TCJA, alimony payments from newer agreements executed on or after January 1, 2019, are no longer taxable income to the person receiving them. Since the income is not taxable, it no longer meets the definition of compensation for IRA purposes and cannot be used to fund an IRA. If a pre-2019 agreement is formally modified after 2018, it may be subjected to the new rules if the modification language explicitly states the alimony is no longer taxable to the recipient.
Contribution Rules with Qualifying Alimony
For individuals whose alimony qualifies as compensation—meaning it is received under a divorce decree dated on or before December 31, 2018—specific contribution limits apply. The amount you can contribute to an IRA for any given year is the lesser of two figures: the statutory annual contribution limit or your total compensation for the year. For 2024, the annual IRA contribution limit is $7,000, or $8,000 for those age 50 or older.
This rule means your contribution cannot exceed your income. For example, if an individual’s sole source of income is $20,000 in qualifying alimony, they can contribute the full annual maximum of $7,000 (or $8,000 if over 50). However, if that person’s only income was $4,500 in qualifying alimony, their maximum allowable IRA contribution for the year would be capped at $4,500.
Consequences of Incorrect Contributions
Making an IRA contribution using non-qualifying income, such as alimony from a post-2018 divorce agreement, results in what is known as an excess contribution. This can lead to financial penalties. The IRS imposes a 6% excise tax on the amount of the excess contribution for each year that it remains in the account.
To avoid the tax, the individual must withdraw the ineligible contribution, along with any investment earnings it has generated, by the tax filing deadline for the year the contribution was made. For instance, if an improper contribution was made for the 2024 tax year, it must be withdrawn by the tax filing deadline in April 2025 to prevent the 6% penalty from being applied.