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How Roth IRA Contributions Are Taxed

Contributions to a traditional IRA are made with pre-tax dollars and may be tax-deductible, depending on your income and if you or your spouse are covered by a retirement plan at work.

If you are eligible to deduct your traditional IRA contributions, it will lower the amount of your gross income that’s subject to taxes. And that effectively lowers the amount of tax you owe for that year.

When you start withdrawing from these accounts after your retirement, however, you’ll pay taxes on those funds at your ordinary income tax rate. That's why the traditional IRA is called a "tax-deferred" account.

10%

The percentage of taxpayers in the United States that have a Roth IRA, according to the Tax Policy Center.9 

Roth IRAs do not benefit from the same upfront tax break that traditional IRAs receive. The contributions are made with after-tax dollars. So, a Roth IRA will not reduce your tax bill for the year that you make contributions.

Instead, the tax benefit comes at retirement, when your withdrawals are tax-free.6

 

Traditional IRA vs. Roth IRA

It is also true no matter how large your profits. If your contributions over the years earn $100,000 in profits—or $1 million for that matter—the earnings still grow tax-free. And you have already paid the income taxes on the contributions you made.1

By comparison, you pay income taxes on both the contributions and the earnings in a traditional IRA. If you contributed to a traditional IRA and earned that same $100,000 in profits, you would owe taxes on both the contributions and the earnings at your ordinary income tax rate when you make a withdrawal.

This is the key distinction between Roth and traditional IRAs.6




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