Should You Open an IRA While You're on Unemployment?

It’s possible, but understand the rules, and consider other financial goals

A couple discusses their IRA at a glass table in their home
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Unemployment numbers have fallen since spiking to nearly 15% in April 2020. The unemployment rate was 5.9% in June 2021, but millions of people in the U.S. continue to worry about their immediate financial needs even with the decline. The current situation may feel urgent, but retirement is still going to come.

Depending on your situation, you may be wondering whether it’s a good idea to contribute to an individual retirement account (IRA), or whether it’s even an option at this point in time. Here’s what you need to know about opening an IRA, especially if you’re one of the many people in the U.S. on unemployment.

Key Takeaways

  • To open an IRA, you—or your spouse if you file a joint tax return—must have received taxable compensation during the year.
  • Your eligibility is based on your income for the full year, not just right now.
  • Prior earned income during the year before you became unemployed may make you eligible.
  • Make sure you know the rules and best practices to accomplish your retirement goal without sacrificing your present financial health. 

Who Can Open an IRA? 

IRAs can provide significant tax benefits to people who are saving for retirement, but not everyone can open one. You must meet two requirements, according to the Internal Revenue Service (IRS):

  • You must be under age 70 1/2 at the end of the year in which you open the account.
  • You, or your spouse if you file a joint tax return, must have received taxable compensation during the year.

“Compensation” is generally money you earn from working. It can include salaries, wages, commissions, self-employment income, taxable alimony and separate maintenance, and nontaxable combat pay. The IRS does not consider unemployment income to be earned income.

You can open an IRA if you’ve earned any of these forms of income during the year in which you’re unemployed, no matter how much. Both you and your spouse can open an account if you’re unemployed, but your spouse is still working.

You can still open an IRA if you’re on unemployment benefits now, but you were working and earning income earlier in the tax year.

You aren't eligible to set up an IRA if you’re unmarried without any earned income this year, or if you're married, but neither of you has received eligible compensation the entire year.

Can I Contribute to an IRA While on Unemployment?

The same rules apply if you already have an IRA or you’re thinking of opening one. You—or your spouse, if applicable—must have earned income to make contributions.

You may be able to contribute up to the 2021 maximum of $6,000 each, or $7,000 if you’re age 50 or older, if you’re on unemployment benefits but your spouse is still working.

Remember that your eligibility is based on income for the full year, not just the present time. You may be limited as to how much you can contribute based on your income, however. For example, you’d likely be limited to $3,500 in contributions for the year if you only earned $3,500 in eligible income for the year.

Why Would I Want to Open an IRA?

There are a few reasons to consider opening an IRA while you're unemployed. An IRA can make it possible to keep up with your retirement savings plan so you don’t fall too far behind, even if your current situation isn't ideal. You may need to save more going forward to make up for lost time if you wait until you're working again.

The sooner you start saving for retirement, the more you’ll benefit from compound interest.

If your previous employer offered a 401(k) plan, rolling it over into an IRA will allow you to continue to make contributions to your retirement savings and give you more control over how you invest your money.

Strategies for Saving While on Unemployment

There are some clear benefits to saving if it's possible for you to set money aside for retirement while you're unemployed. But are retirement savings a priority when you don't have earned income or a job?

It might not be possible to save for retirement if money is so tight that you need to focus on immediate living expenses. It might make more sense to bolster your emergency savings in these situations. But consider whether you could put that money to better use with other financial goals if you do have some room in your budget that you could put toward your retirement.

“If you've already built up your emergency fund, and you have excess money that you really don't need within the next five years, then taking advantage of tax-deferred growth may be smart," certified financial planner Riley Poppy told The Balance. "An IRA truly is intended as a long-term vehicle. However, definitely evaluate your living expenses in the future. Over-investing living expenses can be dangerous for those unemployed.”

The amount of money you’d save by paying off your credit cards could outpace the benefits you’d get from saving for retirement if you have high-interest card debt.

“[Being] overloaded by credit card or bad debt with interest rates [of] 18% to 24% would hurt people more than what they can gain from any investment in any IRA,” Eric Kam, a financial educator, told The Balance.

Some Tips for Saving

Some more tips can help you make your efforts more effective if you’re in a good place to save for retirement through an IRA.

Make Sure You’re Using the Right Account

There are two types of IRAs: traditional and Roth. The distinction is important because of the way they're taxed, according to Colin Day, a financial advisor with St. Louis-based Correct Capital Wealth Management.

The IRS taxes your Roth contributions now rather than later in life when you make withdrawals, unlike with a traditional IRA, for which you can claim tax deductions for contributions in the year you make them. You'd have a Roth-specific advantage if your income were low this year because of a job loss.

“If you’re in a lower tax bracket in 2020, funding a Roth IRA could make long-term financial sense, because you’ll probably be in a higher tax bracket in retirement,” Day told The Balance. “Because you won’t pay taxes on a Roth IRA, you get the benefit of funding the account in a low tax bracket and pay no taxes later.”

Budget Your Savings

Following a budget won't just help you understand where your money is going. It will also show you where you can cut back in certain areas and reallocate those funds for financial goals like retirement.

Set Up Automatic Transfers

Consider setting up an automatic monthly transfer to your IRA and treating it like any other expense or bill to ensure that it happens. You may be prone to spending whatever money you have leftover if you’re relying on manual contributions to your IRA.

The Bottom Line

Contributing to an IRA while you’re unemployed may not seem possible. But if your household’s financial situation allows for it, make sure you know the rules and the best practices to accomplish your retirement goal without sacrificing your present financial health.