How Can I Invest If I Don’t Have Earned Income?

Dear Carrie,

I’m an unmarried, 100 percent disabled veteran. My VA disability compensation is my only source of “income.” Are there any tax-advantaged investment vehicles (besides IRAs) for me to grow my (already) tax-free disability benefits? I have very limited income but I’d still like to invest for my future. What’s the best way for a disabled veteran to build wealth and break the cycle of poverty when we can’t take advantage of IRAs or 401(k)s?

—A Reader

Dear Reader,

I’m forever thankful and in awe of the tremendous sacrifice that you and so many other veterans have made for this country to protect our many freedoms. Thank you for your service.

Unfortunately, as you point out, your lack of “earned income” does indeed eliminate certain options like a 401(k). In a similar vein, I often hear from retired readers who are also frustrated because they want to continue to save and invest.

Being a disabled veteran further complicates this issue. However, there are still options available to help you build wealth. Let’s first take a look at some tax-advantaged choices and then turn to taxable options. All can be effective ways for you to invest for your future.

What counts as earned income?

Under IRS rules, "earned income" consists of taxable wages, salaries, tips or some other form of paycheck. While long-term disability payments before 65 can be considered earned income, VA disability payments, military or other private pensions, and Social Security are not considered earned income. Neither are interest and dividends from investments, unemployment benefits or child support.

Additionally, under the recently passed Tax Cuts and Jobs Act of 2017, alimony received by someone divorced or separated after December 31, 2018 is no longer considered earned income.

This means that none of these sources of income can be used to contribute to an IRA, 401(k), 403(b), or 457(b). While that may be disappointing, you can still save and invest.

Health Savings Accounts (HSAs)

HSAs are one of my favorite tax-advantaged investing options and I’ve written about them in earlier columns. Contributions are 100 percent tax-deductible, your savings grow tax-free and withdrawals are tax-free if used for qualified health expenses. To contribute to an HSA, you must have a High Deductible Health Plan (HDHP), and you can't be enrolled in Medicare.

Veterans with an HDHP may still be able to contribute to an HSA if they receive hospital care or medical services administered by the Department of Veterans Affairs for a service-connected disability.

529 Achieve a Better Life (ABLE) Accounts/529A

These tax-advantaged accounts are a form of special needs trust for individuals disabled before age 26 (you can open one later if you were disabled before age 26).

ABLE accounts allow individuals and families to contribute up t0 $15,000 (2020) a year with a lifetime total contribution of $100,000 without impacting certain means-tested federal/state aid benefits like Supplemental Social Security (SSI), Supplemental Nutrition Assistance Program (SNAP), and Medicaid.

Contributions are not federally tax-deductible, but distributions of investment earnings are federally tax-free if used for qualified disability expenses.

These qualified expenses are written pretty broadly and may include education, housing, transportation, employment training and support, personal support services, health care expenses, and other expenses that help improve health, independence, and/or quality of life for the designated disabled beneficiary.

ABLE accounts were designed from 529 College Savings Accounts and are sometimes also called 529A accounts. There are about 40 states that offer them and each has its own cost structure, investment options, and rules. You can open an ABLE account in any state that accepts outside residents into their program. (By the way, you don’t need earned income to contribute to 529 College Savings Plans either.)

ABLE contributions may also be eligible for the Saver’s Credit, which is a type of tax credit that can reduce your tax bill. You can learn more about ABLE accounts at ABLE NRC.

After-tax annuities

Another tax-deferred option for those without earned income, these are also referred to as non-qualified deferred annuities. Key benefits include no contribution limits and no required distributions. That said, withdrawals of earnings prior to age 59½ are subject to ordinary income rates and an additional 10 percent early withdrawal penalty.

In their purest form, annuities are designed to provide guaranteed income. They can be a good solution for some individuals seeking retirement income; however, they can be complex and have higher costs than other investment options. Be sure to work with a trusted professional before you proceed.

Another option—spousal IRAs

You say you're unmarried now, but I want to mention spousal IRAs because they're one of the most overlooked opportunities for married couples to save for retirement. Spouses without earned income can still contribute to an IRA if they are a joint filer with a worker who does have earned income.

Brokerage accounts

The main investing option is a regular brokerage account, which allows you to invest in everything from mutual funds, to ETFs, to individual stocks and bonds.

A brokerage account isn't tax-sheltered so you’re subject to taxes on the interest and dividends you receive and on gains from the sale of investments. You can lower the tax bite by using tax managed or low turnover exchange traded funds (ETFs) or mutual funds. A powerful benefit of taxable accounts is that if an asset is held for more than one year, any gain on its sale may qualify for the long-term capital gain rate of 0-20 percent, as compared to 10-37 percent ordinary income rates that apply to IRAs, annuities or 401(k) withdrawals.

There are no limits to how much you can save, and you can make penalty-free withdrawals at any time. As I always remind readers, do your research before you invest and be mindful of your risk tolerance and time horizon.

You can always save and invest

As I hope you can now see, there are potentially many effective ways for you to invest if you don’t have earned income.

As a disabled veteran, you’ll want to be extra careful about any earnings or savings strategies that may impact any means-tested benefits you may be receiving. Contact an attorney and work with the VA for more assistance.

That said, I encourage you to take full advantage of both tax-deferred and taxable accounts. If you continue to save and invest over time, you will be well on your way to a financially secure future. Best of luck, and once again, thank you for your service.

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.

Please note: This article may contain outdated information about RMDs and retirement accounts due to the SECURE Act 2.0, a law governing retirement savings (e.g., the age at which individuals must begin taking required minimum distributions (RMDs) from their retirement account will change from 72 to 73 beginning January 1, 2023). For more information about the SECURE Act 2.0, please read this article or speak with your financial consultant. (1222-2NLK)