Taking Care of Mom and Dad: The Second Most Common Plan: IRA
Individual retirement accounts are similar to 401(k) plans, as they provide tax benefits for long-term investments -- but on a smaller basis. Your parents can set up an IRA account at most banks, brokerage firms or mutual fund companies.
An IRA is created by a written document. The document must show that the account meets all of the following requirements:
- The trustee or custodian must be a bank or other institution approved by the IRS to act as trustee or custodian.
- The trustee or custodian generally cannot accept contributions of more than a set amount ($3,000 in 2003 or $3,500 if the account owner is 50 or older).
- Contributions, except for rollovers, must be in cash.
- The account owner must have a nonforfeitable right to the amount at all times (this means he or she can't use the money as security for a loan, etc.).
- Money in the account can't be used to buy life insurance.
- Assets in the account can't be combined with other property, except in a designated common investment fund.
Your parents can have a traditional IRA whether or not they are covered by any other retirement plan. However, they may not be able to deduct all of their contributions, depending on what tax breaks they are already taking on other retirement accounts.
That said, your parents can make contributions to an IRA if:
- at least one of them received taxable compensation during the year; and
- they were not age 70½ by the end of the year.
What is compensation? Generally, it's money your parents earn from working. Wages, salaries, tips, professional fees, bonuses and any other amounts they receive for providing personal services are compensation. So are commissions.
If your parents are self-employed (proprietors of or partners in the business in which they work full-time), compensation is the net earnings from their business (provided their services are a material income-producing factor) reduced by contributions made on their behalf to retirement plans and a portion of their self-employment taxes.
For IRA purposes, compensation also includes any taxable alimony and separate maintenance payments either of your parents receive under a decree of divorce or separate maintenance.
Compensation doesn't include any of the following:
- earnings and profits from property, such as rental income, interest income and dividend income;
- pension or annuity income;
- deferred compensation received (compensation payments postponed from a past year);
- income from a partnership for which they do not provide services that are a material income-producing factor; and
- any extraordinary amounts excluded from income, such as foreign earned income and housing costs.
For any year in which your parent does not work, contributions cannot be made to the IRA unless he or she receives alimony or files a joint return with a spouse who has compensation. Even if contributions can't be made for a given year, the amounts contributed for previous years can remain in the IRA. Contributions can resume for any year that your parent has compensation that qualifies.
Contributions can be made to an IRA at any time during the year or by the due date for filing a return for that year, not including extensions. For most people, this means April 15 of the following year.
