Individual retirement accounts (IRAs) are tax-advantaged accounts that provide certain taxpayers with a means of setting aside a part of their earnings toward their retirement years. There are two primary types of individual retirement accounts; traditional IRAs and Roth IRAs. One of the primary differences between these two types of IRAs involves whether the accounts are funded with pre-tax or after-tax dollars.
Roth IRA Contributions
You can only fund your Roth IRA with after-tax dollars -- money on which you have already paid taxes. Unlike contributions to a traditional IRA, which are typically tax deductible, you may never take a tax deduction for contributions to your Roth when you file your federal income tax return.
Withdrawal of Contributions
One significant benefit of funding your Roth IRA with money on which you have already paid taxes is you can withdraw amounts from your Roth IRA, up to your total contributions, without causing a taxable event. Since you have already paid taxes on those funds, the Internal Revenue Service (IRS) treats them as they would funds in any other demand deposit account. You can take withdrawals of the contribution portion of your Roth account without reporting it to the IRS.
Earnings in a Roth IRA
The earnings portion of your Roth IRA is allowed to grow tax deferred for as long as it remains inside the account. All earnings are treated the same, regardless of how they are earned. This allows you to invest in a wide variety of securities and savings products without giving consideration to the tax implications of their earnings. Interest, dividends, capital gains and royalties are all treated the same. They are not taxed at all as long as they remain in your Roth IRA.
Withdrawal of Earnings
Since you have not paid income taxes on the earnings portion of your Roth individual retirement account, the earnings will be subject to taxation as ordinary income at your tax rate at the time of withdrawal, plus an additional 10 percent tax penalty if you withdraw them before they are qualified. Earnings must remain in your Roth account for five years to become qualified. Once the earnings are qualified, you may withdraw them tax-free if you meet one of the IRS's other requirements, such as reaching age 59 1/2 years, becoming disabled or using the withdrawal to pay for a first home. Your beneficiaries may take a tax-free withdrawal of the earnings in your Roth IRA in the event of your death.
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