If you are pursuing graduate studies such as PhD, or conducting a research project, you will receive some form of compensation known as a stipend.
A stipend is often lower than regular wages, and it is used to cover basic costs while you receive training or conduct a study. You can use the money to pay for food, housing, internet bills, etc.
However, if you plan to use the money to save for retirement, you may wonder whether stipends are eligible for 401(k). Does it meet the IRS criteria for contributing to a retirement plan?
Let’s get right into it.
Are Stipends Eligible For 401k Contributions?
Whether stipends are eligible for 401(k) or not depends on several factors, including the nature of the stipend, the rules of your employer’s 401(k) plan, and whether they are taxable or not.
Eligible compensation usually includes regular salary, wages, bonuses, and certain other forms of compensation. If the stipend is considered part of your eligible compensation under the plan, you can contribute a portion of it to your 401(k) plan.
Additionally, Stipends are categorized differently for tax purposes. Some stipends may be considered taxable income, while others may not. If a stipend is considered taxable income, it might be eligible for 401(k) contributions as long as it falls within the plan’s definition of eligible compensation.
What is a stipend?
A stipend is a form of compensation that is paid to certain employees for work performed, or while receiving training. Mostly, this benefit is provided in addition to the regular salary a worker is paid and is used to offset certain costs like hotel and meals.
Some of the common recipients of stipends include students, interns, clergy, and research follows. The payment allows the recipient to pursue work that is often unpaid, by helping offset certain costs. Apart from the monetary benefit, a stipend can include other benefits like room and board.
When paying stipends, employers must follow the existing rules, including withholding taxes for certain types of stipends.
Is a stipend considered income?
Stipends do not qualify as wages earned, and most employers do not withhold part of the benefits for taxes such as Medicare and Social Security. However, the benefit may still count as taxable income, and you will need to set aside part of the money for the income taxes you will owe at the end of the year.
While a salary is paid for work performed and is a set amount, a stipend is not considered a form of compensation for work. Stipends are generally lower than a salary, and they are not regulated by the government. Instead, they are provided at the discretion of the employer.
When to contribute to 401(k) if you earn a stipend
You have a taxable income
You can only contribute to a retirement plan if you have earned income. If your only source of income is stipends, you may not be eligible to contribute to a qualified retirement plan. But, if you have other earned incomes such as salaries, you will be eligible to contribute to the 401(k) plan.
You have another eligible source of income
Find a part-time or full-time job where you will earn a salary. For example, you might work as a teaching assistant, research assistant, or part-time employee. Income from these sources can make you eligible to contribute to a 401(k) plan.
Alternative Options If You Can’t Contribute to a 401(k)
Open an IRA account
Even though you might not be eligible for 401(k) contributions, you might consider opening an IRA. IRAs have different contribution rules and may be more suitable if you have limited income. Plus, you will have a bigger pool of investment options to help you diversify your investments.
Open a Roth IRA
You can decide to open a Roth IRA for your retirement plan. A Roth IRA is funded with after-tax contributions, and you won’t pay taxes when you make qualified withdrawals in retirement. While you will have a lower annual contribution limit than a 401(k), you can roll over your old 401(k)s from previous employers to help you manage your retirement money easily.
Open an investment account
When you open a taxable investment account, you can invest savings in stocks, bonds, and other assets you may desire. Although it doesn’t offer the same tax advantages as retirement accounts, it provides flexibility and accessibility of your funds.
What is eligible compensation for 401(K)?
The definition of the term “compensation” varies across retirement plans, and you should check your plan summary description to know what is eligible compensation.
401(k) plans must define the compensation that the company will use to allocate plan contributions, matching contributions, and profit-sharing contributions. For most employers, eligible compensation includes all W-2 wages, which includes incomes such as salary, bonuses, and commissions.
Some of the eligible incomes included in compensation for 401(k) purposes include:
Salary and Wages
Most 401(k) plans allow employees to contribute a portion of their regular salary and wages to their 401(k) accounts. This includes base salary, hourly wages, and any bonuses or commissions that are considered part of regular compensation.
Overtime Pay
Overtime pay earned by eligible employees is often included as eligible compensation. However, not all plans include overtime pay, so you should review your plan documents for specific details.
Bonuses
Many 401(k) plans allow employees to contribute a portion of their annual or periodic bonuses to their retirement accounts. These bonuses may be discretionary or based on performance.
Commissions
If an employee earns commissions as part of their compensation such as real estate commissions, some 401(k) plans permit contributions from commission income.
Taxable Fringe Benefits
Certain taxable fringe benefits provided by an employer, such as imputed income from employer-provided life insurance over $50,000, fitness stipend, or personal use of a company car, may be included in eligible compensation.
Elective Deferrals
Some 401(k) plans allow employees to make elective deferrals from certain types of compensation, such as bonuses and commissions, in addition to their regular salary.
Incentive Payments
In some cases, incentive payments, profit-sharing contributions, and other similar forms of compensation may be considered eligible income for 401(k) purposes.
What incomes are ineligible for 401k?
Ineligible compensation for a 401(k) plan refers to incomes that are generally not considered eligible for making contributions to a 401(k) retirement account.
While the specific rules may vary depending on the plan, the Internal Revenue Service (IRS) provides guidelines on what types of income are typically ineligible for 401(k) contributions.
Here are some common examples of income that are typically considered ineligible for 401(k) contributions:
Non-Taxable Income
Income that is not subject to federal income tax, such as workers’ compensation benefits, disability benefits, and certain types of insurance proceeds, is typically not eligible for 401(k) contributions.
Excludable Fringe Benefits
Certain fringe benefits provided by an employer that are excluded from an employee’s taxable income such as certain transportation benefits, are generally not eligible for 401(k) contributions.
Deferred Compensation Plans
Income that is already deferred or contributed to other types of retirement plans, such as a traditional pension plan or a 457(b) plan, may not be eligible for additional 401(k) contributions.
Reimbursements
Reimbursements from an employer for expenses incurred by an employee, such as travel or business expenses, are typically not eligible compensation for 401(k) contributions.
Severance Pay
Payments received as severance pay, including lump-sum payments upon termination of employment, are usually not eligible for 401(k) contributions.
Nonresident Alien Income
Compensation paid to nonresident aliens may be ineligible for 401(k) contributions if it is not effectively connected with a U.S. trade or business.
Investment Income
Gains, dividends, or interest income earned from investments, such as stocks, bonds, or rental income, are generally not considered eligible compensation for 401(k) contributions.
Final Thoughts
By now, you should have a pretty good idea of what stipends can and can’t do for your 401(k). Remember, the rules can vary depending on your employer’s plan and the nature of the stipend itself.
So, whether you’re receiving research grants, fellowships, or any other type of stipend, it’s always a smart move to talk to your company’s benefits department or a financial advisor to help you decode the fine print.