Do Earnings From a Roth IRA Count Toward Income?

The major appeal of Roth IRAs is that, if you follow the rules, your withdrawals will never count as income and, as a result, be totally tax-free. But the rules differ depending on whether the money 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.

How Roth IRAs Are Taxed

Unlike a traditional IRA, Roth IRA contributions don’t entitle you to a tax deduction upfront. In financial jargon, they are made with after-tax rather than pre-tax dollars, meaning that the money has already been taxed 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 eventually have to pay taxes when you withdraw them. 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 “5-year rule” or 5-year waiting period. If you don’t satisfy that rule, 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 may also be subject to a 10% tax penalty on early withdrawals. There are some exceptions, as explained in the next section.

Exceptions to the 10% Tax Penalty on Early Withdrawals

The tax laws allow for some exceptions to 10% penalty tax on early withdrawals for both traditional and Roth IRAs. Those include:

• Total and permanent disability
• 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”

Note that, if you die, your IRA beneficiaries will usually 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 totally tax-free withdrawals.

You can find the complete list of exceptions in the IRS publication “Topic No. 557 Additional Tax on Early Distributions From Traditional and Roth IRAs.”

The Bottom Line

If you have a Roth IRA, you can withdraw your contributions at any time and they won’t count as income. The account’s earnings can also be tax-free when you withdraw them as long as you are 59½ or older and you 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, too.

What the Experts Say