03 Nov Can I use my pension as earned income for a Roth IRA?

Q. Is a pension considered earned income? I would like to open a Roth IRA and just wanted to see if I qualify.
— Saver

A. No, you can’t use your pension income to qualify for a Roth IRA.

Pension income is considered earned income in almost all cases, said Jeanne Kane, a certified financial planner with JFL Total Wealth Management in Boonton.

However, she said, just having earned income doesn’t mean that you can contribute to a Roth IRA, or any IRA for that matter.

You need to have compensation, she said.

“Compensation includes only amounts paid for work done that year. It includes salary (W-2 income), net self-employment income and alimony if your divorce was finalized by Dec. 31, 2018,” Kane said.

Given that pension income doesn’t satisfy the compensation requirement to contribute to a Roth IRA, let’s look at your saving options.

If you’re still working, you can contribute but you will be limited to a $6,000 contribution plus a $1,000 catch-up contribution if you’re over 50 years old,” she said. “You may not be able to contribute the full amount if your income is too high.

Your ability to contribute phases out as your income increases, she said.

For those married filing jointly, the phase-outs are between $196,000 and $206,000, and for singles and heads of household it’s between $124,000 and $139,000.

If you’re retired, you have options.

“You could find a ‘fun’ job or figure out a way to get paid for volunteer work that you love,” Kane said. “You could then contribute your compensation earned up to $6,000 plus an additional $1,000 catch up contribution to a Roth IRA.”

If you don’t spend all of your pension and don’t want to work, you can look to saving and investing options, she said.

Like a savings account.

“You can put your pension income into your bank account or in Certificates of Deposit,” she said. “Bank interest rates are below 1% so your money won’t make much. You need to watch out for inflation because if you are earning less than inflation, your buying power will be worth less in the future.”

Or you could try a taxable account.

With this type of investment account, you put in after-tax money and you only pay taxes on its growth. If you hold the investments for more than a year, you pay preferred long-term capital gains taxes which can be 0%, 15%, 20% depending on your income, Kane said.

She recommends you only invest money that you won’t need for five years, particularly if you’re on a fixed income.

“Investments go up but they can also go down as we saw this year,” Kane said. “A five-year time frame will give your money enough time to grow and recover from any losses should they occur.”

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This story was originally published on Nov. 3, 2020.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.