The Internal Revenue Service taxes different types of income at different levels. For example, your salary and wages are taxed as ordinary income while capital gains on your investments might be taxed as either short-term or long-term capital gains. You don't have to worry about different types of taxation when it comes to the earnings in your Roth individual retirement account. If they are taxed at all, they are taxed as ordinary income.
Roth Investment Gains
Any gains produced by investments held inside your Roth IRA are allowed to grow on a tax-deferred basis for as long as they remain inside your Roth account. It doesn't matter whether that growth was the result of dividends, interest or gains from trading capital assets. Neither the short-term capital gains rate or the long-term capital gains rate applies to investments held in your Roth IRA.
Withdraw Contributions Tax-Free
Since you have already paid taxes on the money you contributed to your Roth IRA, you can withdraw that money anytime you want without paying any additional income taxes. The Internal Revenue Service considers this type of transaction to be a non-taxable return of contribution rather than a distribution, so neither ordinary income taxes nor capital gains taxes apply.
The distributions in your Roth IRA become "qualified" -- meaning that you will not pay any income tax at all, even on the gains the account has earned -- once you have had a Roth account for at least five years and you are either permanently disabled, age 59 1/2, or withdrawing up to $10,000 for a first home purchase.
All of the money in your Roth IRA, including any earnings on investments in the account, belongs to you. You can withdraw those funds anytime you wish, for any reason, but there are tax consequences if you take a non-qualified distribution of any of the earnings. All non-qualified distributions of earnings are taxed as ordinary income in the year you receive them, regardless of how those earnings were produced or how long you've held the investment. Non-qualified earnings distributions are also subject to an additional 10 percent tax penalty in addition to any income tax due.
- Internal Revenue Service: Publication 590, What Are Qualified Distributions?
- Internal Revenue Service: Publication 590, Additional Tax on Early Distributions
- Internal Revenue Service: Publication 590, Ordering Rules for Distributions
- Fairmark: Tax-Free Distributions from Roth IRAs
- Internal Revenue Service: Roth IRAs
- Internal Revenue Service: Topic 409 - Capital Gains and Losses
- Internal Revenue Service: Publication 590, Introduction
- Internal Revenue Service. "Topic No. 451, Individual Retirement Arrangements (IRAs)." Accessed April 2, 2020.
- Internal Revenue Service. "Instructions for Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts," Page 3. Accessed April 2, 2020.
- Internal Revenue Service. "Topic No. 309, Roth IRA Contributions." Accessed April 2, 2020.
- Internal Revenue Service. "Income ranges for determining IRA eligibility change for 2021." Accessed Nov. 2, 2020.
- Internal Revenue Service. "IRA FAQs -- Distributions (Withdrawals)." Accessed April 2, 2020.
- Internal Revenue Service. "Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs)." Accessed April 2, 2020.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.