Roth IRA Funding Rules
What are the Roth IRA funding rules?
Can anyone contribute to a Roth IRA, or is it restricted?
These are great questions. Fortunately, most people can contribute to a Roth IRA.
Assuming you meet the Roth IRA income limits established by the IRS, you need to take note of the following funding requirements.
Roth IRA contributions can only be made:
Let's look at each of these Roth IRA funding rules individually in order to gain a firm grasp of each concept.
Funding A Roth IRA With Earned Income
The Roth IRA funding rules mandate you use a specific type of income to make Roth IRA contributions.
In order to fund your Roth IRA, you must have "compensation." So what's "compensation"?
According to IRS Publication 590:
Some of the more common forms of compensation include:
Some of the more common forms of income which are NOT compensation include:
So generally speaking, if you don't "work" to earn it, it doesn't count as "compensation" in the eyes of the IRS.
For example, let's say you have a business partnership selling produce on the side of the road.
You grow the produce in your garden, and spend weekends at harvest time manning your roadside produce stand.
Under the Roth IRA funding rules, as long as you file taxes claiming your business income ("under the table" income can't be used for Roth IRA contributions), then you're eligible to use income from your business partnership to make a Roth IRA contribution.
Because you "worked" for it.
But what if you have a business partnership where you don't work?
For instance, let's say you provided your daughter with seed money to start a business, and as a result, you get annual profits from the business.
Can you use these profits to make a Roth IRA contribution?
Not unless you "work" to generate profits for the business.
According to the IRS, compensation does NOT include:
So unless you're performing services or "work" which generate income, you can't use that income to make a Roth IRA contribution.
Contributions Can Not Be Greater Than Compensation
Assuming you have eligible compensation, the Roth IRA funding rules state that you can't contribute more than you generate in eligible compensation.
For example, if you're 16 years old and you generate $1,500 in eligible compensation, you can make a Roth IRA contribution of any amount up to and equal to $1,500. But you can't contribute more.
If you contribute $1,501 or more, then you've made an excess Roth IRA contribution.
Also keep in mind that although you may earn a certain amount of compensation, you can't necessarily contribute all of it, because you first have to pay taxes.
Funding A Roth IRA With After-Tax Dollars
The Roth IRA funding rules also require you to make Roth IRA contributions with after-tax dollars.
Unlike contributions to other tax-sheltered retirement accounts, such as your 401k, Traditional IRA, or 403b, contributions to a Roth IRA are NOT tax deductible.
So you realize no immediate tax benefit as a result of funding your Roth IRA.
However, in the long-term, you receive enormous tax benefits. Because under the Roth IRA withdrawal rules, you can withdraw most funds from your account tax-free and penalty-free after age 59 ½.
For example, let's say you're 25 years old, earn $25,000, and you're in the 10% tax bracket.
If you contribute $5,000 to a tax-deductible Traditional IRA, you end up with $5,000 in your IRA and $18,000 in take home pay ($25,000 - $5,000 * 10%).
On the flip side, if you contribute $5,000 to a non-deductible Roth IRA, you end up with $5,000 in your Roth and $17,500 in take home pay ($25,000 * 10% - $5,000).
While you end up with an extra $500 in your pocket today as a result of making a tax deductible Traditional IRA contribution, you may not end up with more in your pocket tomorrow.
Remember, withdrawals from your Traditional IRA are fully taxable in retirement. What if your tax rate in retirement is 20% or 30% instead of the 10% you're paying now?
With a Roth IRA contribution, it doesn't matter - your retirement withdrawals are tax-free!
Roth IRA Maximum Annual Limit Funding Rules
The Roth IRA funding rules also limit the amount you can contribute to your Roth IRA in any given tax year.
Assuming your annual income falls below the lower-level range established by the Roth IRA income limits, you're eligible to make the maximum Roth IRA contribution.
So what is the maximum annual Roth IRA contribution?
The maximum dollar amount you can contribute to your Roth IRA is:
The extra $1,000 for those 50 years old and older is considered a "catch-up" contribution for those nearing retirement.
For instance, let's say you earn $57,000 per year, and you want to make the maximum annual contribution to your Roth IRA.
If you're 43 years old, you can contribute $5,000.
But if you're 53 years old, you can contribute $5,000 plus an extra $1,000 catch-up contribution for a grand total of $6,000.
Funding Rules For Roth IRAs
Before you open and fund your Roth IRA, you need to know and understand the Roth IRA funding rules.
Below are the important points to remember:
Commit these key points to memory, and you'll know just about everything you need to know about the funding rules for your Roth IRA.
Check out our new Facebook Page and follow us on Twitter!
Return to the top of Roth IRA Funding Rules
Return to the Your Roth IRA Website Homepage
Read 5 Reasons Why I Love My Roth IRA, our part in the Good Financial Cents Roth IRA Movement!
Start planning ahead for next year by checking out 2017 Roth IRA contribution limits, and stay alert to this year's changes to the 2016 Roth IRA contribution limits.
Our family fully funds our Roth IRA with this website. Learn how you can do it too.
Are you confused or frustrated by the stock market? Learn how to build real wealth selecting individual stocks for your Roth IRA...
Read more about what's new on the Roth IRA blog.
Hi, I'm Britt, and this is my wife, Jen. Welcome to our Roth IRA information website!
This is our humble attempt to turn a passion for personal finance into the Web's #1 resource for Roth IRA information. But, believe it or not, this site is more than just a hobby. It's a real business that provides a stable and steady stream of income for our family. In fact, because of this site, Jen is able to be a full-time stay-at-home mom and spend more time with our daughter, Samantha.
But you want to know the best part? ...You can do the same thing! Anyone with a hobby or a passion (even with no previous experience building a website) can create a profitable site that generates extra income.
If you're tired of solely depending on your job(s) for family income, click here now and learn why our income is increasing despite the financial crisis and how we're making our dreams come true.
Search This Site
Roth IRA Basics
More About Roth IRAs
Roth IRA Resources
About Your Roth IRA
Like Us On Facebook
Follow Us On Twitter
[?] Subscribe To
The information contained in Your Roth IRA is for general information purposes only and does not constitute professional financial advice. Please contact an independent financial professional when seeking advice regarding your specific financial situation.
Our family started this site as a labor of love in February 2009, a few months after our daughter was born.
Thank you for helping it become one of the most visited Roth IRA information sites.
Thank you, too, to the "SBI!" software that made it all possible.
We hope you find what you're looking for and wish you much continued success in your retirement planning!