Update 2/22/2022: Great news! The point of this article has been fulfilled because the IRS re-revised Publication 970 for tax year 2021 to reflect the current tax code, which permits taxable graduate student and postdoc income, whether reported on a Form W-2 or not, to be contributed to an IRA.
Publication 970 p. 5 NOW states: “Individual retirement arrangements (IRAs). You can set up and make contributions to an IRA if you receive taxable compensation. A scholarship or fellowship grant is generally taxable compensation only if it is shown in box 1 of your Form W-2, Wage and Tax Statement. However, for tax years beginning after 2019, certain non-tuition fellowship and stipend payments not reported to you on Form W-2 are treated as taxable compensation for IRA purposes. These include amounts paid to you to aid you in the pursuit of graduate or postdoctoral study and included in your gross income under the rules discussed in this chapter. Taxable amounts not reported to you on Form W-2 are generally included in gross income as discussed later under Reporting Scholarships and Fellowship Grants.”
The rest of this article is unchanged from its original publication date on 2/6/2022.
Believe it or not, I look forward to the release of each new version of the IRS’s Publication 970, which covers how fellowship and scholarship income is taxed. I read it thoroughly and make sure that what I teach is in line with it. However, when I opened up the new 2021 version a few days ago, I was disappointed to read on p. 5: “Individual retirement arrangements (IRAs). You can set up and make contributions to an IRA if you receive “taxable compensation” (formerly “earned income”). Under this rule, a taxable scholarship or fellowship grant is compensation only if it is shown in box 1 of your Form W-2, Wage and Tax Statement.” Disappointed doesn’t really touch the depths of my feelings… I was momentarily devastated! I’ve been telling you for over two years now that fellowship income is eligible to be contributed to an IRA regardless of how it is reported or not reported at tax time. Was I wrong? Let’s explore the relevant texts. I have great respect for the IRS publications and find them very useful, but they are not the final word on tax law… the tax code is.
- Fellowship Income Is Now Eligible to Be Contributed to an IRA!
- Do I Owe Income Tax on My Fellowship?
- Weird Tax Situations for Fellowship and Training Grant Recipients
- What Your University Isn’t Telling You About Your Income Tax
- Fellowship and Training Grant Tax Forms
You must have “taxable compensation” to contribute to an IRA in a given tax year. You can contribute up to the cap for that year ($6,000 in 2019-2022) or your amount of taxable compensation, whichever is lower.
Through tax year 2019, with respect to PhD trainee income, only income reported on a Form W-2 was considered “taxable compensation.”
The text from the 2019 version of Publication 970, Tax Benefits
for Education, reads on p. 5: “Individual retirement arrangements (IRAs). You can set up and make contributions to an IRA if you receive taxable compensation. Under this rule, a taxable scholarship or fellowship grant is compensation only if it is shown in box 1 of your Form W-2, Wage and Tax Statement. For more information about IRAs, see Pub. 590-A and Pub. 590-B.”
Similarly, the text from the 2019 version of Publication 590A, Contributions to Individual Retirement Arrangements (IRAs), reads on p. 6: “Scholarship and fellowship payments are compensation for IRA purposes only if shown in box 1 of Form W-2.”
This text is very clear and reflects the widely held understanding of eligibility for IRA contributions. It was very disappointing for many members of the PhD community; winning a fellowship often comes with a pay raise and therefore an enhanced ability to save for retirement, yet those recipients were barred from making IRA contributions. Keep in mind, these fellowships were taxable as ordinary income, just not considered taxable compensation for IRA contribution purposes. I didn’t like this rule, but I taught it as part of my personal finance material.
The Graduate Student Savings Act
Somehow, the plight of graduate students and postdocs who received fellowship income was heard! The Graduate Student Savings Act proposed to change the definition of taxable compensation. It was put before Congress as a bill in 2016, 2017, and 2019.
An excerpt of the fact sheet for the Graduate Student Savings Act of 2019 reads: “While fellowship or stipend income is taxed by federal and state governments, it doesn’t qualify as “compensation,” meaning that none of a student’s fellowship funds can be saved in an IRA… Many postdoctoral fellows… also receive taxable fellowship income, yet these fellows are also barred from using their fellowship income to contribute to tax-preferred retirement accounts. The Graduate Students Savings Act of 2019 would ensure that any graduate student or postdoctoral fellow who is
paid for their work or their studies can save a portion of their stipend in an IRA.”
While not using super specific or technical language, this excerpt makes clear the intent of the bill: to allow “any graduate student or postdoctoral fellow who is paid for their work or their studies” to contribute to an IRA, i.e., change the definition of taxable compensation.
Graduate Student Savings Act was not successful in being passed as an independent bill in any of those years. Then, in 2019, it was included in the SECURE Act.
The SECURE Act
The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) is described by Investopedia as a “far-reaching bill includes significant provisions aimed at increasing access to tax-advantaged accounts and preventing older Americans from outliving their assets.” It was signed into law on December 20, 2019.
The Graduate Student Savings Act was included in the SECURE Act. Here is the relevant text from the bill:
“SEC. 106. CERTAIN TAXABLE NON-TUITION FELLOWSHIP AND STIPEND PAYMENTS TREATED AS COMPENSATION FOR IRA PURPOSES.
“(a) In General.—Paragraph (1) of section 219(f) of the Internal Revenue Code of 1986 is amended by adding at the end the following: “The term ‘compensation’ shall include any amount which is included in the individual’s gross income and paid to the individual to aid the individual in the pursuit of graduate or postdoctoral study.”.
“(b) Effective Date.—The amendment made by this section shall apply to taxable years beginning after December 31, 2019.”
This expands the definition of taxable compensation for the purposes of contributing to an IRA beyond what is reported on a Form W-2. To me, this definition clearly includes taxable fellowship and training grant income paid as stipends and salaries not reported on a Form W-2.
The Tax Code (2021)
From the current Internal Revenue Code section 219 on Retirement Savings, section (f)(1) reads:
“(1) Compensation For purposes of this section, the term “compensation” includes earned income (as defined in section 401(c)(2)). The term “compensation” does not include any amount received as a pension or annuity and does not include any amount received as deferred compensation. For purposes of this paragraph, section 401(c)(2) shall be applied as if the term trade or business for purposes of section 1402 included service described in subsection (c)(6). The term “compensation” includes any differential wage payment (as defined in section 3401(h)(2)). The term “compensation” shall include any amount which is included in the individual’s gross income and paid to the individual to aid the individual in the pursuit of graduate or postdoctoral study.”
Again, I read this as any type of grad student and postdoc salary or stipend with no clauses about being reported on a Form W-2. The language is very similar to how IRS Publication 970 describes fellowship income on p. 5: “A fellowship grant is generally an amount paid for the benefit of an individual to aid in the pursuit of study or research.”
The Internal Revenue Code does seem, to me, to reflect the intent of the Graduate Student Savings Act of expanding the definition of taxable compensation with respect to graduate student and postdoc income beyond what is reported on a Form W-2.
The 2021 Publications
As I stated at the start of this article, Publication 970 disappointingly has not changed its tune on the definition of taxable compensation. It says the same thing in 2021 that it did in 2019 as if the Graduate Student Savings Act had never passed.
Publication 590-A, to its credit, now has some mixed language regarding taxable compensation and fellowship stipends and salaries. I’ll compare the 2018 and 2021 versions of this publication.
The 2018 version of Publication 590-A contains exactly one reference to fellowship income on p. 6 in the section titled What Is Compensation?: “Scholarship and fellowship payments are compensation for IRA purposes only if shown in box 1 of Form W-2.”
The 2021 version of Publication 590-A contains this language on p. 6 in the section titled What Is Compensation?: “Scholarship and fellowship payments are compensation for IRA purposes only if shown in box 1 of Form W-2.” So no change there.
However, further down in the same section it says: “Graduate or postdoctoral study. Compensation includes any income paid to you to aid you in the pursuit of graduate or postdoctoral study.”
Are they trying to draw a distinction between “any income paid to you to aid you in the pursuit of graduate or postdoctoral study” and “scholarship and fellowship payments”? What could “any” income mean if not, at least in part, fellowship payments?
To further muddy these waters, Publication 590-A includes Table 1-1, Compensation for Purposes of an IRA. The 2018 version of this table doesn’t mention either fellowship income or graduate or postdoctoral study. The 2021 version lists “taxable non-tuition fellowship and stipend payments” as included in the definition of taxable compensation.
This language in the table is consistent with both employee and non-employee graduate student and postdoc income, again, with no mention of a Form W-2 reporting requirement.
Furthermore, the 2021 version of Publication 590-A says under the Reminders section on p. 2: “Certain taxable non-tuition fellowship and stipend payments. For tax years beginning after 2019, certain taxable non-tuition fellowship and stipend payments are treated as compensation for the purpose of IRA contributions. Compensation will include any amount included in your gross income and paid to aid in your pursuit of graduate or postdoctoral study.”
I am not sure what “certain” means in this paragraph. “Non-tuition fellowship and stipend payments” reads to me as stipend or salary as long as your tuition is being paid by another source of funding. “Any amount included in your gross income and paid to aid in your pursuit of graduate or postdoctoral study” reads to me as both your employee income (reported on a Form W-2) such as from a graduate assistantship position or postdoctoral employee position and taxable non-employee (not reported on a Form W-2), often sourced from a fellowship or training grant.
My conclusion is that the very clear language in Publication 970 and Publication 590-A excluding taxable fellowship and scholarship income from the definition of taxable compensation unless it is reported on a Form W-2 is not consistent with the spirit of the Graduate Student Savings Act or the current tax code. The changes made by the SECURE Act to the tax code included in the definition of taxable compensation “any amount which is included in the individual’s gross income and paid to the individual to aid the individual in the pursuit of graduate or postdoctoral study.” To me, this means that if you receive a taxable stipend or salary as a graduate student or postdoc, even if it is not reported on a Form W-2, it is taxable compensation for the purpose of contributing to an IRA.
What Do You Think?
I am really struggling with this and I honestly want to know: Do you see a flaw in my reasoning? Is there some difference between “fellowship” and “any income paid… in the pursuit of graduate and postdoctoral study”? Leave a comment here or email me (emily@PFforPhDs.com). I am open to the idea that there is something I don’t see or understand. Or let me know if you agree with me.
What Can We Do?
If my argument is valid and the text in IRS Publication 970 and Publication 590A (in part) is incorrect, what can be done? Hit me with your ideas for getting this text updated.
My initial idea is to write to the offices of the Senators (Elizabeth Warren, Mike Lee, Ron Wyden, and Tim Scott) who sponsored the Graduate Student Savings Act to see if they can clarify why the IRS’s language in these publications doesn’t reflect the change the Act brought about. Do you have any other ideas?
The big win for our community was getting the Graduate Student Savings Act passed. The follow-through on that win is making sure that people (and tax software/preparers) know about the change so that graduate students and postdocs can functionally contribute to IRAs.
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I think the biggest thing here is the risk you take by contributing fellowship funds to an IRA when the IRS has conflicting language. Is it worth risking the IRS auditing you and paying penalties? I’m hesitant to contribute any of my fellowship money until the publication language is clarified.
I can understand that. How do we go about correcting the language to be consistent?
Completely agree. I contributed to a roth last year using NSF GRFP fellowship income (after law change allowed me to do so). This is a mistake on part of IRS (forms do not match law). Definitely needs correcting! The guidance does not match the change in U.S. code. Interestingly enough — turbotax does not mark my roth IRA contribution as “ineligible” when I punch it in along with my fellowship income (it would have in the past). So the tax software networks have adjusted to the change. I plan to continue contributing this year…IRS guidance is not correct.
That’s good to know about TT. I heard that FreeTaxUSA made the same change during the 2020 tax season. I’m glad to know you agree with my reasoning!
I definitely agree with the reasoning. The law is far more clear than the documents from the IRS, and the idea that it has to be on a “W-2” seems to defeat the entire purpose of the act, which you point out.
I usually use turbo tax, although thinking of switching this year because of cost. It is reassuring to see that TT and other filing companies are following the law more directly than the IRS documents.
Thanks for this post, Emily!
Thanks for your comment! I’m glad to know you agree.
Thank you for this post! I am a fellow and started contributing to a Roth IRA this year, so this is super relevant for me. Re some of the comments here about TurboTax etc, it didn’t occur to me that it would affect my taxes at all though.. isn’t the whole point that it’s a post tax contribution?!
Roth IRA contributions don’t get reported on your tax return, but software does ask about contributions so that it can check whether they’re allowable, e.g., not enough taxable compensation, too high of an income.
Ahhh, got it, that makes sense! Thank you!
I am using HR Block to file my taxes and it says I have to pay a penalty fee for excess Roth IRA contribution even though I definitely paid under the limit. I guess HR Block has not made the adjustments.
I’m disappointed but not too surprised… I’m generally not a fan of the brand.
I am using H&R Block. The taxable amount of the Fellowship (since it is not shown on W-2) is not recognized by the software as income. The income amount shown on my W-2 is less than my 2021 contribution($6000). It tells me that I have over contributed to the Roth IRA. It says I need to withdraw the over contributed amount before the filing deadline to avoid penalty.
Update, using H&R Block, I was able to input the taxable fellowship income (not on W-2) manually and it went through without warning about penalty
Hi Emily, thanks as always for your helpful advice and this thorough article! I am using FreeTaxUSA (highly recommend to other grad students) and it allows me to contribute my fellowship income toward a Roth IRA without penalty. At first, the software told me the contribution was not allowed, but that was just because I missed checking a box in my “Other income” section: “Are any of your scholarship or fellowship grants entered above from graduate or postdoctoral fellowship or stipend payments?”
FreeTaxUSA says that they refer to IRS Pub 590, which does allow taxable non-tuition fellowship and stipend payments as “compensation”
TL;DR: Yes you should be allowed to contribute I think, according to the 2021 590a! Use FreeTaxUSA and you’ll be able to do it.
Very good to know! And I’m glad that software is working well for you.
Here to report that TaxAct has not updated their software and throws an error for excess contribution. Trying to get it sorted but looking like I may need to re-do everything in TurboTax or FreeTaxUSA
Hi Emily – I actually think the IRS publication is fairly clear and that you are correct. This sentence seems fairly conclusive:
for tax years beginning after 2019, certain non-tuition fellowship and stipend payments not reported to you on
Form W-2 are treated as taxable compensation for IRA
With that said I have to sadly agree with the others about tax software – TaxAct has not been updated and is explicitly taking the opposite interpretation of yours (and the law) and penalizing contributions that are made with fellowship stipend income. I’ve emailed and tried contacting TaxAct numerous times at the beginning of January but haven’t heard back from anyone. I’ll be switching to FreeTaxUSA.
I also had an issue with HR Block, but successfully used freetaxusa.com to file without a Roth IRA contribution penalty. Shane’s advice above about checking the box in the “other income” section was really helpful!
While reading about this I saw that if you don’t have a retirement plan through work (which many of us postdocs don’t), your traditional IRA contributions are completely tax deductible (!!). I opened a Roth IRA under the assumption that it was better to pay taxes now than later, when I’ll be earning more, but now I’m wondering if it doesn’t make more sense to open a traditional as well— if I understand this correctly, out of the ~8k taxes I owe, I could put 6k of that into a traditional IRA and only owe 2k? But then I couldn’t contribute to the Roth… very confusing, I’d love to see a post from you on this!
It’s not that good of a deal! You have to multiply the amount of the deduction, $6k, by your marginal tax bracket (e.g., 12%, 22%) to calculate the amount of tax you will save. (I’m assuming that the final $6k of your income falls in only one marginal tax bracket, not over two.) What you’re describing is how a credit works.
If my fellowship amount is less than my qualified expenses, can this fellowship amount be used as a basis for an IRA contribution? Example:
No other eligible income.
No. The fellowship is compensation, but it’s not taxable.
Thanks so much for your breakdown of these laws. What’s your take on contributions for a postbacc? Nothing is explicitly said about them so should I contribute? Or not? What are your thoughts?
Postbacs are not carved out as an exception category, so if I were in your shoes I would not consider it taxable compensation. But remember you can have income outside of your awarded stipend count as taxable compensation, e.g., from earlier/later in the year or your side hustle. I’d focus on generating that type of income to gain eligibility.
Do you know how all of this applies to 401k or 403b? My institution does not allow NRSA-supported postdocs to contribute to the 403b (even the supplemental plan with no institutional matching), which they state is because of the tax status of the grant funds. I think the recent legal changes should make it possible for the institution to allow all postdocs to contribute their own funds to the 403b through payroll deductions. What do you think? Thanks!
I haven’t investigated whether the change in the definition of taxable compensation would trickle down to 403(b)s… I do know that I have never come across a university 403(b) that allows non-employees to contribute, unfortunately.