Roth IRA contributions and earnings are taxed differently, and when you withdraw money matters

Money you put into a Roth IRA is never taxed when you take it out — you already paid income tax on it before it went in. Earnings (the investment gains) are also tax-free when you withdraw them, but only if you follow the rules: you must be at least 59½ years old and have held the account for at least five tax years. If you withdraw earnings before meeting both conditions, you owe income tax on those earnings plus a 10 percent penalty.

The key distinction is between your contributions (the money you deposited) and your earnings (the growth from investments). The IRS tracks these separately, and the tax treatment depends on which one you are taking out.

Key Takeaways

  • Contributions to a Roth IRA come out tax-free at any age, because you paid income tax on that money before depositing it.
  • Earnings are tax-free only if you are 59½ or older and have owned the account for at least five tax years; otherwise you owe income tax plus a 10 percent penalty on the earnings portion.
  • The IRS considers contributions withdrawn first, so you can take out what you put in without penalty, even if you are young.
  • Conversions from traditional IRAs to Roth IRAs are treated as contributions for the five-year rule, but the money itself was already taxed when you converted it.

When contributions come out tax-free

Your contributions — the actual dollars you deposited into the account — are never taxed when you withdraw them. You paid federal income tax on that money in the year you earned it, before you put it into the Roth. The IRS does not tax it again.

This is true no matter your age or how long you have owned the account. You can withdraw contributions at 25, 35, or 65, and you will not owe tax or penalty. This is one of the major differences between a Roth IRA and a traditional IRA, where withdrawals before 59½ usually trigger a 10 percent penalty.

The catch is that the IRS assumes you withdraw contributions first. If your account has both contributions and earnings, and you take money out, the IRS treats the withdrawal as coming from contributions until those are exhausted. Only after contributions are gone does a withdrawal count as earnings.

When earnings are taxed or penalized

Earnings — the investment returns, dividends, and capital gains your money made inside the account — are tax-free only under specific conditions. You must be at least 59½ years old and have owned the Roth IRA for at least five tax years. Both conditions must be met.

If you withdraw earnings before 59½, or before the five-year mark, you owe income tax on those earnings at your current tax rate, plus a 10 percent early withdrawal penalty. The penalty applies to the earnings portion only, not to contributions.

The five-year rule starts on January 1 of the tax year you made your first contribution to any Roth IRA. If you opened your first Roth in 2020, the five-year period ends on January 1, 2025. All your Roth IRAs count toward this single five-year clock — you do not start a new clock for each account.

Exceptions to the early withdrawal penalty

The IRS allows you to withdraw earnings without the 10 percent penalty in a few situations, though you still owe income tax on the earnings. These exceptions include disability, medical expenses over 7.5 percent of your adjusted gross income, health insurance premiums while unemployed, and a first-time home purchase (up to $10,000 lifetime).

You can also withdraw earnings penalty-free if you are the beneficiary of a deceased account owner, or if you take substantially equal periodic payments under IRS rules. In all these cases, the income tax still applies — only the penalty is waived.

Contributions always come out penalty-free and tax-free, regardless of age or reason, so these exceptions do not change that rule.

How conversions affect the five-year rule

If you convert money from a traditional IRA or 401(k) to a Roth IRA, that converted amount is treated as a contribution for purposes of the five-year rule. You can withdraw the converted amount without penalty after five years, even if you are under 59½.

However, the money you converted was already taxed when you converted it (you paid income tax in the year of conversion). The five-year rule protects you from an additional penalty, not from the tax you already paid. Any earnings that accumulated after the conversion are still subject to the age and five-year requirements.

State taxes and Roth IRAs

Most states do not tax Roth IRA withdrawals, because the federal government does not tax them. However, a small number of states — Pennsylvania, New Jersey, and a few others — tax retirement account withdrawals under certain circumstances. Check your state's tax rules or speak with a tax professional if you live in a state with an income tax.

The federal tax treatment is the same everywhere, but state law varies. Your brokerage or financial institution can tell you whether your state taxes Roth withdrawals.

Frequently Asked Questions

Do I have to pay taxes on Roth IRA growth?

No, the growth itself is never taxed. You pay income tax only if you withdraw earnings before age 59½ and before the five-year mark. Contributions and earnings that stay in the account grow tax-free indefinitely.

Can I withdraw my contributions without penalty?

Yes, always. Contributions come out tax-free and penalty-free at any age. The IRS assumes you withdraw contributions first, so you can access the money you put in without waiting until 59½.

What happens if I withdraw earnings before five years?

You owe income tax on the earnings at your current tax rate, plus a 10 percent early withdrawal penalty. The penalty applies only to the earnings portion, not to contributions. Some exceptions exist (disability, first-time home purchase, medical expenses), which waive the penalty but not the tax.

Does the five-year rule reset if I open a new Roth IRA?

No. The five-year clock starts on January 1 of the tax year you made your first Roth contribution to any account. All your Roth IRAs share the same five-year period. Opening a second account does not restart the clock.

Are Roth IRA withdrawals reported to the IRS?

Your financial institution reports distributions to the IRS on Form 5498-R. You do not have to report contribution withdrawals on your tax return, but you may need to report earnings withdrawals depending on whether you owe tax on them. A tax professional can advise on your specific situation.