Are my Roth IRA earnings taxable? Is a Roth IRA interest taxable? Also, do I claim a Roth IRA on my taxes? If these questions and similar ones are running through your mind, you need to learn how the IRS views Roth IRAs and your earning in it, including the interest it generates.
Compared to other retirement plans the Roth IRA is relatively young. One disadvantage of Roth IRAs over other retirement accounts is that they don't offer upfront tax deductions, but the upside of this is they allow you to make tax-free deductions when you retire.
What this means is you continue to earn interest and other investment income and you don't have to report it on your returns as long as you meet the qualifications for the tax break. In 2021 and 2022, the contributions are set at $6,000. An additional $1,000 is allowed for those who are 50 years or older.
Contributing to a Roth IRA
If you’re looking to invest in a Roth IRA, you have to abide by the phase-out amounts that are based on your modified adjusted gross income. For the 2021 tax year, the amounts are set at $125,000 to $140,000 for singles, heads of households, or those married but filing separately.
For married couples who file joint taxes and qualifying widows and widowers, the phase-out amount is set at $198,000 to $208, 000, which is a slight increase from 2020 amounts was $196,000 to $205,000 for married couples and $124,000 to $139,000 for heads of household and singles.
In the 2022 tax year, the phase-out amounts will climb to $129,000 to $144,000 for singles, heads of households and married but filing single. Married couples and qualifying widows and widowers who file joint taxes are in the phase-out amount bracket of $204,000 to $214,000.
When Do Roth IRA Taxes Apply?
Contributions on a Roth IRA are after-tax, which means you pay your taxes before you make deposits on your Roth account. This means you won't receive a tax break on the year that you made your money.
You receive a tax break after you retire and you withdraw your money. Because you pay your taxes when you make your initial investment, all the returns on your Roth IRA interest income are tax-free.
When to Make Roth IRA withdrawals
Because you've pre-paid your taxes before you deposit money into your Roth account, you can withdraw your money at any time.
However, if you want to withdraw more than you've deposited, you'll be eating into some of your earning. To withdraw the earnings tax-free, you must have attained the age of 59.5. The IRS makes exceptions for special cases such as first-time home buyers and people living with permanent disabilities.
If you haven’t attained the age of 59.5 and haven’t met the requirements, you’ll be required to pay income taxes and an additional 10 percent early withdrawal penalty. If you are older than 59.5 but your Roth account hasn’t been active for five years, you’ll also be required to pay taxes on your account’s earnings.
Are Withdrawals Required After a Certain Age?
Because you've already paid your taxes before depositing into your Roth account, the IRS doesn't care if you withdraw your money or not. A traditional IRA requires you to make minimum withdrawals when you reach the age of 72 so that the IRS can receive taxes for each distribution.
With a Roth IRA, there are no requirements for withdrawals, which means you can leave your money in your account for as long as you like and earn tax-free income as long as you don't make early withdrawals. However, if you transfer your Roth IRA to another party, they may be required to take minimum distributions.
Traditional IRA vs. Roth IRA
With a Roth IRA, it doesn't matter how much income you earn from your investment. It remains tax-free. What's more, you've already paid taxes on your contribution, which means the income you earn is tax-free.
With a traditional IRA, you don't pay taxes on your contribution but you do on your earnings.
Read More: When Do IRAs Mature?
Qualified Roth IRA Withdrawals
If a withdrawal is qualified, it means it’s tax- and penalty-free. The following are instances of qualified Roth IRA withdrawals:
- When you’ve attained the age of 59.5 or older.
- If you have a permanent disability
- When you transfer your account to a beneficiary
- When you want to buy, build or rebuild your first home
- Schwab: What is a Roth IRA?
- IRS.Gov: Retirement Topics - IRA Contribution Limits
- IRS.Gov: Amount of Roth IRA Contributions That You Can Make For 2021
- IRS.Gov: Amount of Roth IRA Contributions That You Can Make for 2022
- IRS.Gov: Topic No. 557 Additional Tax on Early Distributions from Traditional and Roth IRAs
- IRS.Gov: Retirement Plan and IRA Required Minimum Distributions FAQs
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