Whether you're wanting to contribute to an individual retirement account on behalf of your child or help a parent you claim as a dependent sock away some extra retirement money, knowing the eligibility rules helps you maximize the tax benefits of IRAs. Dependents aren't excluded from putting money in a traditional IRA, but they must meet the same eligibility requirements as anyone else.
Often, the hardest eligibility requirement for dependents to meet is having compensation. Compensation includes earned income, such as salary or wages, but not money received as a gift or investment income. Dependents earning less than the annual limit can only contribute up to the amount of compensation. For example, you can't give children or elderly dependents who didn't have any earned income money to put in an IRA.
Though Roth IRAs don't have any age limits, traditional IRAs limit how old you can be and still contribute, whether you're claimed as a dependent or not. Dependents who turn 70-1/2-years-old before the end of the year can no longer add funds to a traditional IRA. There is no minimum age necessary to contribute to a traditional IRA, however, so age isn't an issue for dependent children.
Traditional IRAs don't have any income limits on who can contribute. However, Roth IRAs do limit who can contribute, based on your modified adjusted gross income. Chances are, a dependent won't run into any problems with the income limits. You can claim dependent children, though, no matter how much they make as long as they don't pay for more than 50 percent of their expenses. So, if your children have a high income from employment, gifts or investments it's possible their income could exceed the annual limits.
No Money Tracing
The Internal Revenue Service doesn't require that dependents strictly use their compensation income to fund their IRAs. As long as they have enough compensation to justify the IRA contribution, the IRS doesn't care where the money that goes into the IRA comes from. For example, if your son had $5,000 of compensation that he used for basic living expenses, you can give him $5,000 to put in an IRA.
- tax forms image by Chad McDermott from Fotolia.com