Can I fund existing IRA with brokerage cash via bank

[pkrabbendam]

Question on funding an existing IRA (rolled-over 401K from a previous employer).

I understand a brokerage account isn't a qualified retirement plan so I cannot do a direct transfer, but I would still like to use its cash to fund the IRA with a tax deductible 2020 contribution.

Is it allowed to: 

Step 1 Move cash from the Brokerage to my bank account;

Step 2 Move that cash from the bank account to the IRA?

I think "yes" but I can't find a definitive answer and the last thing I want is get into trouble with a three letter acronym government agency...  Thanks much in advance!

[macuser_22]

You must have the IRA custodian make the contribution to your IRA.   The administrator must report it to the IRS.  Ask the account administrator for the methods you can use.  

It does not matter where the money comes form as long as you have sufficient taxable compensation (money that you worked for) on your tax return.

The maximum IRA contributions for 2020 is $6,000, or $7,000 if you’re age 50 or older by the end of the year; or your taxable compensation for the year which ever is less.

(Taxable compensation is generally wages that you worked for - W-2 or net self-employed income minus the deductible part of the SE tax, but can include commissions, certain alimony and separate maintenance, and nontaxable combat pay ).

See IRS Pub 590A "What is compensation" for details:
https://www.irs.gov/publications/p590a#en_US_2020_publink1000230355

See this IRS link for Traditional IRA deduction limits when covered by a retirement plan at work.

https://www.irs.gov/Retirement-Plans/IRA-Deduction-Limits

[pkrabbendam]

Thanks for that very fast response @macuser_22 !!

For clarification, I am already retired so my income is from Social Security, Interest and Dividends.

Both the IRA and Brokerage are self-directed. When I go to Transfer Cast option on their website and select my bank account in the From list and the IRA account in the To list it shows a box where I can specify the contribution to be for 2020 or 2021, and contributions to date, so I interpret this as being a valid funding method since in fact I am instructing the account administrator (Merrill) to do the needful, correct?

[macuser_22 · Accepted solution]

See IRS publication above.  Social Security, Interest and Dividends cannot fund a IRA contribution .   Only money from the listed activities (mainly W-2 income or net Self-employed income) can fund an IRA.

Since money is fungible it does not matter what account it comes from as long as you have at least that amount of taxable compensation - on the 1040 line 1 (W-2) or Schedule 1 line 3 (Self-employed - line 14). 

Otherwise it will be an excess contribution subject to penalty that repeats every year until the excess is removed.

[pkrabbendam]

Thanks again @macuser_22 

I truly appreciate your sharing your expertise!

[TuckerdogAVL]

I have a similar question. I thought it may help to ask here vs. starting a new thread. I recently sold some holdings in my IRA account that are underperforming. I have enough cash in the IRA now where I could fund 2022 Contribution. Can I use some of that cash to fund my 2022 contribution without penalty? I will be 68 at the end of this year if that matters. 

[macuser_22]

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@TuckerdogAVL wrote:

I have a similar question. I thought it may help to ask here vs. starting a new thread. I recently sold some holdings in my IRA account that are underperforming. I have enough cash in the IRA now where I could fund 2022 Contribution. Can I use some of that cash to fund my 2022 contribution without penalty? I will be 68 at the end of this year if that matters. 

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No.  That is not "taxable compensation" as defined in IRS PUB 590A as stated in my answer above.

[Critter-3]

You cannot use the cash  IN an  IRA  to make a NEW CONTRIBUTION  TO AN IRA.   Contributions to an IRA must be made  from earned income  outside of the IRA.  

[VolvoGirl]

@Critter-3  I think we covered that in this thread and his other one.   He does have self employment income.  For some reason he wants to take a IRA withdrawal and pay tax on it.   Then use that money to make a contribution based on his se income.  Which would be ok.

[TuckerdogAVL]

Without being rude or snarky, oh wait,i’m online… i think i answered the reason why regarding the paying taxes on the withdrawal. But, allow me to explain. If you have retirement funds and all of those are taxable, and anything you take out of a portfolio has a cost basis that is 20000% less than the current value ( not a typo), then you can pay taxes on that sale, or pay taxes on this sale, to use the money to pay taxes on withdrawals.. We can’t live on the income from social and freelance alone.  We have cable hahahaha. that alone is 1500 a year. and a mortgage, and food and running water. Let alone pay the taxes. So, instead of selling something off i was looking at a way to get the ira contribution done, taken off the list, checked off, rather than selling positions. Any clearer now? And at my age, had i not dealt with **bleep**ty financial advisors 20 years ago, I’d have done Roth’s and other things. All the financial advice is great when your 35, but no help when all ur assets are taxable. 

[macuser_22]

You still have not explained what type of account you are selling.    If just a regular brokerage account - not an IRA, then as I said before, you can use that money to fund an IRA contribution as long is the contribution is not more than yiu earned income.   For self-employed that is the 1010 Schedule 1, line 3 amount minus line 14 (your self-employed income minus the deductible part of the SE tax).

If you are taking the money FROM an existing IRA then putting that back into the IRA as a contribution then that makes no sense at all - it would not gain anything and you would have to pay tax on the distribution.

[TomD8]

@TuckerdogAVL wrote:  "So, instead of selling something off i was looking at a way to get the ira contribution done, taken off the list, checked off, rather than selling positions."

Then you have to fund the IRA contribution with funds from another source.  Do you have uninvested cash in your brokerage account?  Do you have other savings?  Can you use your freelance income?  Do you have any capital losses you could use to offset your capital gain if you do sell securities?

Remember that if you sell securities from your non-retirement account, your gain will be taxed at the lower capital gains tax rate, not as ordinary income.

[Opus 17]

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@TuckerdogAVL wrote:

I have a similar question. I thought it may help to ask here vs. starting a new thread. I recently sold some holdings in my IRA account that are underperforming. I have enough cash in the IRA now where I could fund 2022 Contribution. Can I use some of that cash to fund my 2022 contribution without penalty? I will be 68 at the end of this year if that matters. 

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The bottom line here is that pulling the cash out of the IRA is a taxable event, period.  Once the money is in your bank account, you can do anything you want with it, but each transaction is treated separately.  You certainly could use that money to make an IRA contribution if you have taxable income from working.

But I don't really see the point.  You withdraw $12,000, pay $5,000 of income taxes, then contribute $7000 back into the IRA--how does that help you?

It sounds like you have a cash position in your IRA, you want to leave the cash in the IRA and call it a contribution.  That's incorrect for multiple reason; for one thing, it's already tax-free, so you can't take a second tax deduction for it.  You would have to withdraw it, pay the taxes, then put it back, which makes no sense at all.   

Something you might want to do, depending on your tax bracket, is withdraw some IRA money, pay the tax, then contribute it to a Roth IRA.  (Or you can do this directly via a Roth conversion.)  Roth IRAs are not taxable when withdrawn in the future, and converting some of your taxable IRA to non-taxable Roth (which essentially means paying the tax now rather than later) can make sense for some people.  Of course, you must have compensation from working to contribute to a Roth IRA, but it does not have to be the same money.  (You don't have to put your specific freelance check into the Roth, you can do the Roth contribution with different dollars as long as you have received the compensation in some form.) 

[TuckerdogAVL]

 I put the money in the IRA and SEP to reduce the amount of federal taxes, so a ROTH doesn't help in this case. The IRA and SEP are for those purposes. I have other retirement accounts. I am looking into the new IRA (don't recall what it is) that has the trick where you can't wait until April, you have to open it before December). Maybe I can rollover funds into that. 

[TuckerdogAVL]

Thanks.