Roth individual retirement accounts are great for saving money when you're in a lower tax bracket than you expect to be in when you're taking withdrawals. Plus, the money grows tax-free as long as it remains in the account. However, the Internal Revenue Service sets limits on what types of contributions Roth IRAs can accept and who's eligible to contribute each year.
Counts as Annual Contribution
Your brokerage account isn't a qualified retirement plan, so you're not allowed to transfer money to your Roth IRA like you would from another retirement plan, even if you do a direct transfer. For example, if you convert money from a traditional IRA to a Roth IRA, there's no limit on how much you can move in one year because it's a conversion, not an annual contribution. But, since your brokerage account isn't qualified, you can't contribute more than your annual limit, which is $6,500 if you're 50 or older, or $5,500 if you're under 50, as of 2013.
To qualify to make a contribution to your Roth IRA, you need compensation and your modified adjusted gross income can't exceed the annual limits. Compensation doesn't include stock gains, just your income from working and your taxable alimony. The IRS doesn't care if you don't use the exact dollars that you got from working for your Roth IRA contribution. For example, say your $80,000 salary all went into your checking account. You're still allowed to contribute from your brokerage account, even though none of those dollars were compensation. The income limits vary by filing status and increase with inflation, so check IRS Publication 590 for the updated limits.
Must Contribute Cash
Roth IRAs can only accept monetary contributions, such as cash or a check. Roths aren't allowed to accept contributions of property, even if the value is easily established, as with publicly traded stocks. If your brokerage account doesn't have enough cash in it to contribute the amount you want, you must sell some shares, deposit the proceeds in the Roth IRA, and then buy new shares in the Roth IRA, even if you're just repurchasing the same stock.
Excess Contribution Penalties
If you transfer money from from your brokerage to a Roth IRA when you're not eligible to contribute, the IRS docks you for making an excess contribution. The penalty equals 6 percent of the excess every year that you don't correct the excess. For example, if you put in $10,000 thinking it's a rollover, when you're not allowed to contribute, you will owe a $600 penalty each year you don't fix it. But, you can save yourself the penalty if you take out the contributions, plus any earnings, before your tax-filing deadline, including any extensions.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."