IRAs are tax-deferred, not tax-free — but the tax treatment depends on the account type and when you withdraw

An IRA is not tax-free. Money grows inside an IRA without being taxed each year, but you will owe taxes when you take the money out. The amount you owe depends on whether you have a traditional IRA or a Roth IRA, and when you withdraw.

With a traditional IRA, contributions may be tax-deductible in the year you make them, but withdrawals are taxed as ordinary income. With a Roth IRA, contributions are made with after-tax dollars, but may have access to withdrawals — those taken after age 59½ and at least five years after opening the account — come out tax-free. The growth inside a Roth is also never taxed, as long as you follow the rules.

Key Takeaways

  • Traditional IRA contributions may lower your taxable income now, but withdrawals are taxed as regular income when you take them out.
  • Roth IRA contributions are made with money you have already paid taxes on, so may have access to withdrawals and the growth inside are never taxed.
  • Withdrawals before age 59½ from either account type usually trigger a 10 percent penalty on top of income tax, with limited exceptions.
  • Required minimum distributions (RMDs) from traditional IRAs begin at age 73 and are taxed as ordinary income.

How traditional IRA taxes work

In a traditional IRA, you may deduct your contributions from your taxable income in the year you make them — but only if you meet income limits and do not have access to a workplace retirement plan. The money grows without annual tax bills, but when you withdraw, the full amount (contributions plus growth) is taxed as ordinary income at your current tax rate.

If you contributed to both a traditional IRA and a Roth IRA in the same year, the deduction limit applies to both combined. For 2024, you can contribute up to $7,000 per year (or $8,000 if you are 50 or older), and the deductible amount phases out based on your income and whether you have a 401(k) or similar plan at work.

When you turn 73, you must begin taking required minimum distributions (RMDs) from your traditional IRA each year. These withdrawals are taxed as ordinary income, and the IRS charges a 25 percent penalty on any amount you fail to withdraw (reduced to 10 percent if you correct the error within two years).

How Roth IRA taxes work

A Roth IRA works backward: you contribute after-tax money (no deduction), but withdrawals are tax-free if you meet two conditions. You must be at least 59½ years old, and you must have owned the Roth for at least five tax years. If both conditions are met, you withdraw contributions and growth completely tax-free.

The five-year rule is per account, not per person. If you open a Roth IRA at age 58, you cannot take tax-free withdrawals until age 63 at the earliest — even if you have owned other Roths longer. However, you can always withdraw your own contributions (not the growth) from a Roth at any time without tax or penalty.

Roth IRAs have no required minimum distributions during your lifetime. You can leave the money untouched as long as you want, and the growth continues tax-free. This makes a Roth useful if you do not need the money in retirement or want to pass it to heirs.

Early withdrawal penalties and exceptions

If you withdraw from a traditional IRA before age 59½, you owe income tax on the amount plus a 10 percent penalty. A Roth IRA lets you withdraw contributions penalty-free at any time, but withdrawing growth before 59½ triggers the same 10 percent penalty (though not income tax on the growth itself, since it was never deducted).

The IRS allows penalty-free early withdrawals in specific situations: a permanent disability, medical expenses over 7.5 percent of your adjusted gross income, health insurance premiums while unemployed, a first-time home purchase (up to $10,000 lifetime), and substantially equal periodic payments under IRS Rule 72(t). These exceptions apply to both traditional and Roth IRAs, though the tax treatment differs.

If you inherit an IRA from someone other than a spouse, the rules changed in 2024. You must withdraw the entire balance within ten years, and those withdrawals are taxed according to the original account type (traditional withdrawals are taxed as income; Roth withdrawals are tax-free if the five-year rule was met).

Conversions from traditional to Roth

You can convert money from a traditional IRA to a Roth IRA at any time. The amount converted is taxed as ordinary income in the year of conversion, but once it is in the Roth, it grows tax-free and can be withdrawn tax-free after age 59½ and five years of ownership.

Conversions are useful if you expect to be in a lower tax bracket in the conversion year, or if you want to lock in current tax rates before they rise. However, the conversion itself creates a tax bill in that year. If you convert $50,000 from a traditional IRA to a Roth and you are in the 24 percent federal tax bracket, you will owe approximately $12,000 in federal income tax on the conversion.

There is no income limit on Roth conversions, but if you have a traditional IRA, SEP IRA, or SIMPLE IRA with pre-tax money, the IRS applies the "pro-rata rule." This means a portion of your conversion is treated as taxable based on the ratio of pre-tax to after-tax money across all your IRAs. Consult a tax professional before converting if you have multiple IRAs.

Taxes on IRA investment income and growth

Inside an IRA — whether traditional or Roth — you do not pay annual taxes on interest, dividends, or capital gains. If you own stocks that pay dividends or bonds that pay interest, those earnings are not taxed each year the way they would be in a regular brokerage account. This tax deferral is one of the main reasons IRAs are useful for long-term saving.

In a traditional IRA, this tax deferral is temporary: you pay the tax when you withdraw. In a Roth IRA, the deferral is permanent — the growth is never taxed, even after you withdraw. This is why a Roth is often more valuable if you have a long time horizon and expect significant growth.

State taxes on IRA withdrawals

Federal income tax applies to traditional IRA withdrawals in every state, but state income tax varies. Some states do not tax IRA withdrawals at all, while others tax them the same way they tax other income. A few states exempt retirement income above a certain age or income level.

If you are planning to move in retirement, check your current state's rules and your destination state's rules. Moving from a state with income tax to one without (such as Florida, Texas, or Nevada) can reduce your tax bill significantly, though you must establish residency to claim the exemption.

Frequently Asked Questions

Can I withdraw from my Roth IRA without paying taxes?

Yes, if you are at least 59½ and have owned the Roth for at least five tax years. You can also withdraw your contributions (not growth) at any time without tax or penalty. Withdrawals of growth before 59½ are taxed and penalized.

Do I have to pay taxes on a traditional IRA conversion to a Roth?

Yes. The amount you convert is taxed as ordinary income in the year of conversion. If you convert $50,000 and are in the 22 percent bracket, you owe roughly $11,000 in federal tax that year. The conversion itself does not trigger the early withdrawal penalty, even if you are under 59½.

What happens if I do not take my required minimum distribution?

The IRS charges a 25 percent penalty on the amount you failed to withdraw (reduced to 10 percent if you correct it within two years). You still owe income tax on the amount you should have withdrawn. RMDs begin at age 73 for traditional IRAs and apply to inherited IRAs regardless of age.

Are inherited IRAs taxed differently?

Yes. If you inherit a traditional IRA, withdrawals are taxed as ordinary income. If you inherit a Roth IRA and the five-year rule was met, withdrawals are tax-free. You must withdraw the entire balance within ten years (with limited exceptions for spouses and disabled beneficiaries).

Do I pay taxes on dividends and interest inside my IRA?

No. Interest, dividends, and capital gains inside an IRA are not taxed annually. In a traditional IRA, you pay tax when you withdraw. In a Roth IRA, you never pay tax on the growth if you follow the rules.