How Roth IRA taxes work: Contributions, withdrawals & conversions

Saving in a tax-advantaged retirement account, like a Roth IRA, can be a powerful way to help lay the foundation for a financially secure retirement. Not only do Roth IRAs offer a variety of investment options, but the earnings in the account can compound and grow completely tax-free.

Here's a breakdown of how Roth IRA taxes work during the life of the account: when you make contributions, take withdrawals, or decide to do a Roth conversion.

Unlike its counterpart the traditional IRA, Roth IRAs do not provide an upfront tax deduction for your contributions because you fund a Roth account with after-tax dollars. The money you contribute to a Roth IRA has to be from earned income where the taxes have been deducted already. The tax advantages of Roth IRAs come at a different point in time.

There are limits to the amount you can contribute to a Roth IRA. The 2024 contribution limit is $7,000, with an additional $1,000 catch-up contribution if you’re 50 or older.

However, some people are not allowed to contribute at all if their income is too high. Before you deposit money into a Roth IRA, you need to ensure you are eligible.¹

Make too much to contribute to a Roth IRA? Check out these alternatives

While putting money into a Roth IRA does mean you pay taxes now, you can reap some significant tax-free benefits when it comes to withdrawal time.

Roth IRA withdrawals, also known as distributions, offer more flexibility than traditional accounts but have more nuances:

Since you've already paid the income tax on the dollars you put into a Roth IRA, you're allowed to withdraw up to the total amount of your contributions at any time. You don't have to wait until you've reached any specific age, and you can use those funds for any purpose.

In a Roth IRA, you don't pay taxes on any investment growth or earnings while your money remains in the account. If you make a qualified withdrawal (you meet the five-year rule and have reached age 59½), the growth and earnings are never taxed. This tax-free aspect lends to the power of Roth accounts.

If your withdrawal is not qualified, the earnings portion of the withdrawal will be subject to your income tax rate when you report your taxes for the year. It depends on which qualifications you meet:

• If you haven't met the five-year rule, your earnings will be taxed regardless of reaching age 59½ or not.
• If you have met the five-year rule but haven't reached age 59½, your earnings will be taxed unless you meet one of three conditions: you're making a first-time home purchase ($10,000 lifetime maximum), you've become disabled or you've died.
  

The government doesn’t impose required minimum distributions (RMDs) on Roth IRA account holders. That means you can let your money grow tax-free and withdraw it tax-free for as long as you like. It's the major benefit of saving with a Roth account.

Free Roth IRA calculator

Creating a Roth IRA can make a big difference in your retirement savings. Use our calculator to estimate potential long-term savings.

Try it out

Directly contributing to a Roth IRA isn't the only way to fund one. You also can convert money held in a tax-deferred retirement account, like a traditional IRA, into a Roth IRA.

When you do, the amount you convert is included in your taxable income for that year. But then that amount becomes just like any other money in your Roth IRA and can grow and be withdrawn tax-free.

Facing the tax implications of converting to a Roth IRA makes sense when you believe that you are in a lower tax bracket now than you will be in retirement. By converting, you take advantage of the lower tax rate.

• Conversions are not subject to income or dollar amount limitations the way contributions are. Anyone can convert any amount they have available to them regardless of their income.

• There is a different five-year rule that applies to conversions. If you withdraw any amount of your converted dollars within five years, the money will be subject to the early withdrawal penalty if you are younger than 59½ or an exception applies. Unlike the other five-year rule that only needs to be satisfied once, each conversion has its own five-year clock.

Although Roth IRAs are intended for retirement savings, they can play a significant role in estate planning. The beneficiaries of your Roth IRA gain certain tax advantages as well.

If you were to leave a beneficiary a traditional IRA, the money they take out would be taxable. With a Roth IRA, however, your beneficiaries may be able to take withdrawals tax-free.

Most IRA beneficiaries are required to withdraw all the money within 10 years, but spouses who inherit IRAs and certain others have more flexibility.