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How Roth IRA Taxes Work | Retirement

Key Takeaways:

  • With a Roth IRA, you can pay taxes on your retirement savings during your working years if you meet the income limits.
  • You make contributions to a Roth IRA with after-tax money.
  • If you meet the requirements, including having the account open for at least five years and being 59 1/2 or older, Roth IRA withdrawals are usually tax-free.
  • If you take early withdrawals, you could pay taxes and a penalty unless you qualify for an exception.

A Roth IRA allows you to pay the taxes on your retirement savings while you are still working, but there are rules regarding contributions and eligibility for tax-free withdrawals in retirement. If you don’t carefully follow the rules, you may have to pay taxes or penalties on the investment earnings.

When saving in a Roth IRA, keep these factors in mind:

  • Contribute after-tax funds to a Roth IRA.
  • No taxes are due while the money is in the Roth IRA.
  • Roth IRA withdrawals in retirement are typically tax-free.
  • When you need to pay taxes on the Roth IRA investment earnings.

Contribute After-Tax Funds to a Roth IRA

While traditional IRAs allow you to defer paying income tax on your retirement savings, you deposit after-tax funds in a Roth IRA. “Roth IRAs provide tax-free growth of investments by way of after-tax contributions,” said Jeff Wright, founder and wealth advisor at Wright Wealth in Atlanta, in an email.

In 2024, the limit on how much you can contribute across IRAs is $7,000. If you are 50 or older, the limit is $8,000. Your filing status and level of income could impact the contributions you’re allowed to make. Eligibility to make Roth IRA contributions is phased out if you earn more than $146,000 in 2024 as a single filer and $230,000 as a married couple. If you make more than $161,000 as a single filer or $240,000 as a couple filing jointly, you won’t be able to directly contribute to a Roth IRA.

For those who exceed the income limits and want to fund a Roth IRA, there is a backdoor conversion option. “The way the backdoor conversion works is that you can make a nondeductible contribution to a traditional IRA, which has no income limits on nondeductible contributions,” said Joseph M. Favorito, a certified financial planner and principal at Landmark Wealth Management in Melville, New York, in an email. Then you convert the traditional IRA contribution to the Roth IRA right away. “Since you took no deduction on the contribution, there is no taxable income on the conversion to the Roth IRA,” Favorito said. “In addition, there are no income limits on the Roth conversions.”

Making a Roth IRA contribution or conversion earlier in your career could lead to long-term benefits. “Roth IRA contributions and conversions are beneficial for investors in lower tax brackets if they expect to be in a higher tax bracket at the time of withdrawal,” Wright said. “In this case, the investor is paying lower income taxes now than they otherwise would in the future if withdrawing from a traditional IRA.”

No Taxes Are Due While the Money Is in the Roth IRA

Once you’ve made a contribution to a Roth IRA, you won’t have to pay taxes on the money in the account. “The funds grow completely tax-free,” Favorito said. The funds can continue to grow in the account for years or decades.

Plus, if you have an emergency and need to access funds early, “you have full access to withdraw your contributions at any time, with no penalty,” said Cody Lachner, a certified financial planner and founder of Next Adventure Financial in Lafayette, Indiana, in an email. However, taxes and penalties could apply to early withdrawals of investment earnings.

Roth IRA Withdrawals in Retirement Are Typically Tax-Free

To take out the earnings in a Roth IRA without penalty, you must meet certain requirements. The Roth IRA will need to be open for at least five calendar years. You’ll also need to be at least 59 1/2 years old when you start to take funds from the Roth IRA. If you meet these criteria, you won’t pay taxes on the withdrawals of investment growth.

If you choose to leave the funds in the account, you can do so without penalties. This is different than a traditional IRA, which has required minimum distributions after age 73.

When You Need to Pay Taxes on Roth IRA Investment Earnings

If you withdraw earnings from the Roth IRA within five years of opening the account or before age 59 1/2, you’ll have to pay taxes on the withdrawal. You could also face a 10% early withdrawal penalty on the earnings withdrawn if you are younger than 59 1/2.

However, if you go through a financially challenging time and meet certain requirements, you could take funds out without having to pay a penalty. Exceptions to the Roth IRA early withdrawal penalty include:

  • Using up to $10,000 from the account for a first-time home purchase.
  • Using the funds for qualified education expenses.
  • Accessing up to $5,000 to help cover expenses related to a birth or adoption.
  • Being disabled.
  • Paying for significant medical expenses that aren’t covered by insurance.

The tax savings from Roth IRAs can help you build a tax-efficient retirement plan. “Having access to a bucket of money that is not subject to income tax means that a person can be very strategic with how they structure their retirement income,” Lachner said. Money in retirement that comes from pensions, Social Security, traditional IRAs and 401(k)s can increase taxable income. Roth IRA withdrawals can be a tax-free source of retirement income as long as the criteria are met. 

Sarah Goldberg
Sarah Goldberg

Sarah is a seasoned financial market expert with a decade of experience. She's known for her analytical skills, attention to detail, and ability to communicate complex financial concepts. She holds a Bachelor's degree in Finance, is a licensed financial advisor, and enjoys reading and traveling in her free time.

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