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Non-taxable settlement money is not earned income for Roth IRA purpose

Guest gpero

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I was just wondering if you would receive non-taxable money (not earned income) from a court settlement if it would be possible to say take a full paycheck (2000.00) and use it as a contribution to your Roth and then use your non-taxable settlement money to supplement your paycheck. Would this work?

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Lump sum court settlements are not earned income. There is no standard legal way to convert a court settlement into earned income. Therefore if that is your only income source, you do NOT qualify for a Roth. If you have earned income outside of any court settlement which is greater than 2,000 then you qualify for the maximum Roth IRA contribution for that year.

It does not matter if you use taxable or non-taxable funds (assuming you are qualified otherwise with earned income) as that is a tax return issue not a Roth issue. You fund an IRA with just cash. In other words, there is no linkage between source of funds and Roth contributions. Cash is cash. You can even have a relative fund your Roth, but first you must be eligible and that is an earned income issue.

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If I understand the question correctly, as long as you are qualified to fund a roth IRA, where you take the money to fund it is of no consequence. You can just write a check for $2K to the Roth custodian, again, as long as you qualify by having earned income and your total income is within the limits.

Barry Picker, CPA/PFS, CFP

New York, NY


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Guest Paul Leslie

Barry is right. It doesn't matter where you get the money to fund the Roth as long as you meet the other requirements. So as long as you have the $2,000 of compensation reported on W-2 or self employment income. Your tax settlement must be for some type of physical injury which is non taxable IRC 104, so that would not be compensation for IRA purposes.

Paul Leslie


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  • 17 years later...
7 hours ago, Lola said:

I received settlement money from another country, about $40,000. Can i open a Roth IRA  with that money?

See IRS Publication 590-A, starting on page 40, https://www.irs.gov/pub/irs-pdf/p590a.pdf

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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