Unlike the traditional IRA, SIMPLE IRA or SEP-IRA, Roth IRA contributions come from after-tax dollars. Because Roth money is withdrawn tax-free at retirement, the Internal Revenue Service does not allow you to deduct contributions. So, after-tax dollars are the only dollars you can contribute to a Roth account.
Contributions from Earnings
Roth IRA contributions have to come from earned income. Wages, salaries, tips, commissions and taxable military pay are all termed earned income by the Internal Revenue Service. Alimony is also considered earned income. On the other hand, rental income, investment income and inherited monies are not classified as earned income.
Pretax vs. After-Tax Dollars
Pretax money is money from which federal taxes have not been deducted. Employer-sponsored retirement and health savings plans are funded with pretax dollars. The contributions are deducted from your paycheck before federal taxes are taken out. When Congress created the traditional IRA, it granted the account type a similar benefit. Traditional IRA contributions can be deducted from income when you file your tax return. When you withdraw traditional IRA principal and earnings, you pay income tax on the withdrawal. After-tax dollars you report as part of your taxable income. When you receive a paycheck from an employer, you are receiving after-tax dollars -- that is, dollars from which federal taxes have been deducted. You fund your Roth IRA with after-tax dollars; withdrawals are tax-free after retirement age.
Yearly Contribution Limit
With so many tax advantages to hand, the IRS limits the amount you can put into a Roth IRA each year. As of 2012, the limit is $5,000 for those under age 50. For older Roth owners, the limit is $6,000. You can contribute this amount in stages over time or all at once. If you earn less than $5,000 in a year, you cannot contribute the maximum. For example, with earnings of just $2,000, you can contribute no more than $2,000.
You can roll money from another retirement account into a Roth once per calendar year. Many retirement accounts -- such as traditional IRA, 401(k) and 403(b) accounts -- are made up of pretax contributions. When you roll them into a Roth, you have to pay tax on the rollover amount, adding the rollover amount to your adjusted gross income when you file your return. Taxing Roth rollovers assures that all dollars in the Roth account are after-tax dollars.