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When is a Roth IRA Taxed?

2 min read • March 14, 2019
30 sec brief

The answer is: because you’ve already paid taxes on that income. When you contribute to your Roth IRA, it’s with after-tax income. So you don’t get a write-off like you would if you contributed to a 401k or Traditional IRA.

When is a Roth IRA Taxed?

You might have heard of Roth IRA distributions as being “tax-free income” upon retirement.  And technically that’s true.  Once you reach the age of 59 ½ you can start withdrawing your contributions and the money those contributions have earned, without paying a penalty or income tax on the money you receive.  Even if you withdraw money you’ve contributed before you turn 59 ½ you won’t pay income taxes or penalties on the money.

Why are Roth IRA distributions “Tax-Free”?

The answer is: because you’ve already paid taxes on that income.  When you contribute to your Roth IRA, it’s with after-tax income.  So you don’t get a write-off like you would if you contributed to a 401k or Traditional IRA.

However, if you start taking distributions from your Roth IRA before you turn 59 ½ and you take out more than you’ve contributed, thus tapping into the money those contributions have earned, you will not only get hit with a 10% penalty on that money, you will also have to pay income tax on those distributed earnings.

What if I’ve Inherited my Roth IRA?

Inheritance rules are often complicated and for a definitive answer on your specific situation, you should consult an estate attorney.  But generally speaking, distributions from inherited Roth IRAs remain tax-free.

If you’ve inherited the Roth IRA from your deceased spouse, you can roll over their Roth IRA into your personal Roth IRA and the funds will be treated as if they were always yours.  That means the same contribution and distribution rules apply.

If you’ve inherited a Roth IRA as a non-spouse, then you have two options: you can take a lump sum distribution that will get taxed as any other income, or you can roll it into an “inherited Roth IRA”.  If you choose to roll it into an inherited Roth IRA, the gains will continue to grow untaxed. 

The caveat is that you will also have to start taking the “required minimum distribution,” as determined by the IRS based on your age and the amount of money in the account, by the end of the year following your inheritance of the Roth IRA. Those distributions won’t be taxed, but the less money you have in the account, the lower your gains are likely to be. 

Since Roth IRAs give owners a source of tax-free income upon retirement, they can be a great tool for helping you manage your tax liabilities later in life.  This is especially important for people on limited budgets and people who also have pre-tax retirement accounts like 401ks and Traditional IRAs from which they’re required to take a minimum annual distribution upon reaching the age of 70 ½. 

For more information on how Roth IRAs work, check out this post, or contact an accountant.  A professional will not only walk you through the ins and outs of Roth IRAs, but he or she can also help you figure out if this type of retirement account makes sense for you.

About the author
Lauren Hargrave

Lauren Hargrave is a writer from San Francisco who focuses on technology, finance and wellness. She follows comedians like most people follow bands and believes an outdoor sweat session can cure almost any bad mood. She’s also been writing her first novel for so long, her mom doesn’t ask about it anymore.

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