This tax lie is tied with lie #6 as my least favorite because I fervently wish it were true. It makes intuitive sense that everyone with an income should have access to tax-advantaged retirement accounts. However, only income that is taxable compensation is eligible to be contributed to an individual retirement arrangement (IRA).
You can open and make contributions to a traditional IRA if: You (or, if you file a joint return, your spouse) received taxable compensation during the year, and… (Publication 590A p. 5)
Generally, you can contribute to a Roth IRA if you have taxable compensation (defined later) and… (Publication 590A p. 40)
Sounds good so far, right? Typically, when grad students ask themselves if their income is “taxable compensation,” they focus on the “taxable” half of the term. Yes, your grad student income is taxable. But is it “compensation?”
Publication 590 has the answer here, as well. Under the section header “What Is Compensation?” it states:
Generally, compensation is what you earn from working… Scholarship and fellowship payments are compensation for IRA purposes only if shown in box 1 of Form W-2. (Publication 590 p. 6)
Scholarships and fellowships paid to grad students are almost always reported on a 1098-T, a 1099-MISC (box 3), a courtesy letter, or not at all – basically anywhere other than a W-2. So the question of taxable compensation as it relates to grad student income comes down to whether the income was reported on a W-2 (which is typical for assistantships). Grad student pay that is reported on a W-2 is compensatory, while grad student pay reported on a 1098-T, a 1099-MISC (box 3), a courtesy letter, or not at all is non-compensatory.
Further reading: Earned Income: The Bane of the Grad Student’s Roth IRA
If your only source of income in a calendar year is non-compensatory fellowship pay, unfortunately you aren’t supposed to contribute to an IRA for that year. However, if you are married to someone with taxable compensation, you can contribute to a spousal IRA. If you are an unmarried fellowship recipient who really wants to contribute to an IRA, you can consider generating a side income specifically to gain that eligibility. You can contribute 100% of your taxable compensation to an IRA up to $5,500 in 2018.
Further reading: Can a Grad Student Have a Side Income?
Ineligibility to use an IRA, however, is not a reason to give up on your goal of saving for retirement while receiving fellowship income. There are workarounds available so that you can still minimize your tax burden.
Further reading/viewing:
- Fellowship Recipients Can Save for Retirement Outside an IRA
- Webinar: Retirement Investing in a Taxable Investment Account
We at Personal Finance for PhDs are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.
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