The major appeal of Roth individual retirement accounts (IRAs) is that, if you follow the rules, your withdrawals will never count as income and, as a result, be tax free. But the rules differ depending on whether the money that you withdraw represents your contributions to the account or the account’s earnings over time. This article explains when your earnings might count as taxable income—and how to keep that from happening.
- Earnings that you withdraw from a Roth IRA don’t count as income as long as you meet the rules for qualified distributions.
- Typically, you will need to have had a Roth IRA for at least five years and be at least 59½ years old for a distribution to count as qualified, but there are some exceptions.
- If you take a non-qualified distribution, it counts as taxable income and might be subject to a 10% early withdrawal penalty.
How Roth IRAs Are Taxed
Unlike a traditional IRA, Roth IRA contributions don’t entitle you to a tax deduction up front. In financial jargon, they are made with after-tax rather than pretax dollars, meaning that the money has been taxed already when it goes into the account. Instead, you get a tax benefit on the back end in the form of tax-free withdrawals, as long as you follow some fairly simple rules.
Like a traditional IRA, the earnings in your Roth account aren’t taxed each year and can be left alone to grow and compound until you need the money. Traditional IRA earnings are considered tax deferred because you will have to pay taxes eventually, when you withdraw the earnings. Roth IRA earnings, however, can be tax free.
Because your contributions to a Roth IRA are made with after-tax dollars, you can withdraw them at any time, tax- and penalty-free, and they won’t count as income.
However, if you withdraw any of the earnings from your account, they may be taxed differently. For withdrawals, or distributions, of earnings to qualify as tax free, you must have had a Roth account (any Roth account) for at least five years. This is called the five-year rule or five-year waiting period. If you don’t satisfy that rule, then the money you withdraw will be taxed at the same rate as your ordinary income.
If you’re under age 59½ at the time of the withdrawal, you also may be subject to a 10% tax penalty on early withdrawals. However, there are some exceptions.
Exceptions to the 10% Tax Penalty on Early Withdrawals
The tax laws allow for some exceptions to the 10% penalty tax on early withdrawals for both traditional and Roth IRAs. These include:
- If you become totally and permanently disabled
- Withdrawals of up to $10,000 for the purchase of a first home or up to $5,000 for a qualified birth or adoption
- Withdrawals to pay qualified higher education expenses
- Distributions taken in a series of substantially equal periodic payments “for your life (or life expectancy) or the joint lives (or joint life expectancies) of you and your designated beneficiary”
What the Experts Say
Joe Allaria, CFP®
CarsonAllaria Wealth Management, Glen Carbon, Ill.
The easy answer is that earnings from a Roth IRA do not count toward income. If you keep the earnings within the account, they definitely are not taxable.
And if you withdraw them? Generally, they still do not count as income—unless the withdrawal is considered a non-qualified distribution. In that case, the earnings could be taxable. (The IRS website, IRS.gov, explains what defines qualified vs. non-qualified Roth IRA distributions.)
Bear in mind, though, that at no point are you ever forced to take distributions from a Roth IRA, unlike a traditional IRA, where required minimum distributions begin the year (or the year following the year) in which you turn 73.
Note that if you die, your IRA beneficiaries usually will not be subject to the 10% penalty, regardless of their age, as long as the five-year holding period rule has been satisfied. The exception to this exception is for spouses who are sole beneficiaries of an IRA and elect the option of treating it as their own, in which case they must generally wait until age 59½ to be eligible for tax-free withdrawals.
You can find the complete list of exceptions in the Internal Revenue Service (IRS) publication “Topic No. 557 Additional Tax on Early Distributions from Traditional and Roth IRAs.”
What Is a Qualified Distribution?
A qualified distribution, by Internal Revenue Service (IRS) definition, is a distribution or withdrawal that isn’t subject to taxes or penalties. In the case of a Roth individual retirement account (IRA), a qualified distribution is one that meets both the five-year holding period rule and the age 59½ requirement (or an exception to it). Note that withdrawals of contributions to a Roth IRA are always tax free because that money has been taxed already.
Do Roth Individual Retirement Accounts (Iras) Have Required Minimum Distributions (RMDs)?
No, unlike traditional IRAs, Roth IRAs are not subject to required minimum distributions (RMDs) after you reach age 73. If you’re the original account owner, you don’t have to make any withdrawals for as long as you live. After your death, however, your account’s beneficiary or beneficiaries will have to withdraw all the money eventually, although there is an exception for surviving spouses in some instances.
How Much Can You Contribute To a Roth IRA?
The maximum that you can contribute to a Roth IRA in 2023 is $6,500 if you’re under age 50 or $7,500 if you’re older (up from $6,000 and $7,000 in 2022). Note that there are also income limits on your eligibility to contribute to a Roth IRA.
The Bottom Line
If you have a Roth IRA, you can withdraw your contributions at any time and they won’t count as income. Also, the account’s earnings can be tax free when you withdraw them as long as you are age 59½ or older and have had a Roth account for at least five years. If not, you’ll generally owe taxes and may have to pay a 10% early withdrawal penalty.