Roth IRAs can only be funded with earned income, which the IRS calls “taxable compensation.”
In the IRS’ guide for IRA Contributions (Publication 590), taxable compensation explicitly includes: wages, salaries, commissions, self-employment income, alimony, nontaxable combat pay, and “other amounts you receive for providing personal services.” Meanwhile, the following explicitly do not count as compensation: “earnings and profits from property, such as rental income, interest income, and dividend income,” pensions and annuities, deferred compensation, and any income excluded from your return.
Those are the IRS specific examples, but they leave some grey area.
Recently, we received the following reader question:
I have Employer-Provided Group-Term Life Insurance from a former employer. I am retired from work with them but receive a W-2 each year reporting a portion of this benefit which is taxable income for the year. Can I use these “wages” as justification to contribute to my Roth IRA?
If the death benefit of your employer-provided group-term life insurance is $50,000 or less, the Internal Revenue Code Section 79 allows your employer to exclude group-term life insurance premiums from your W-2 reporting. However, if your employer provides group-term life insurance with a death benefit above $50,000, the premiums paid by the employer become partially taxable to the employee. The taxable amount is based on your age and the specific size of the death benefit.
Oddly, these benefits can be provided to former employees as well. If this benefit comes from a former employer, Publication 525 makes clear that the taxable portion of the employer-provided life insurance will also be subject to the payroll taxes of Social Security and Medicare. It states, “You must pay these taxes with your income tax return.”
IRS Publication 525 is explicit that the taxable portion of your employer-provided coverage should be reported as part of your wages in box 1 of Form W-2.
Interestingly, elsewhere in the IRA Contribution publication of IRS Publication 590A, the IRS explicitly states:
The IRS treats as compensation any amount properly shown in box 1 (Wages, tips, other compensation) of Form W-2, Wage and Tax Statement, provided that amount is reduced by any amount properly shown in box 11 (Nonqualified plans).
- The taxable portion of employer-provided group-term life insurance benefits must be reported in box 1 of the W-2.
- Wages in box 1 of your W-2 always count as taxable compensation.
- Therefore, the taxable portion of employer-provided group-term life insurance benefits always count as taxable compensation for the purposes of the IRA contribution limit.
While you may think that this runs counter to the intention of IRA contribution rules, typically any income which you owe payroll taxes on counts as taxable compensation for funding an IRA.
If you have this fringe employer or former employer benefit, I hope you are able to take advantage of making small Roth IRA contributions throughout your retirement.
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