A Roth IRA is not tax-deferred — it is tax-free

The confusion comes from the name. A Roth IRA is not a tax-deferred account. You pay income tax on the money you put in, and then the account grows without any tax bill later. A tax-deferred account — like a traditional IRA or 401(k) — lets you skip taxes now and pay them when you withdraw the money in retirement.

The difference matters because it changes when you owe the IRS. With a Roth, you pay tax upfront on the dollars you contribute. With a traditional IRA or 401(k), you do not pay tax on the contribution itself, but you will owe income tax on every dollar you withdraw after age 59½.

Which one makes sense depends on whether you think your tax rate will be higher or lower in retirement than it is now. If you expect to earn less in retirement, a traditional account saves you money. If you expect to earn the same or more, or if you straightforward want to lock in your current tax rate, a Roth can be the better choice.

Key Takeaways

  • A Roth IRA requires you to pay income tax on contributions now, but withdrawals in retirement are tax-free.
  • A traditional IRA or 401(k) defers taxes until you withdraw money, at which point every dollar is taxed as ordinary income.
  • Roth accounts have income limits that may prevent high earners from contributing directly, while traditional accounts do not.
  • You can withdraw your Roth contributions (not earnings) at any time without penalty, but traditional accounts charge a 10 percent penalty before age 59½.

How tax-deferred accounts work

A tax-deferred account lets you reduce your taxable income in the year you contribute. If you earn $60,000 and put $7,000 into a traditional IRA, you report only $53,000 to the IRS that year. You pay no tax on the $7,000 or on any growth it earns inside the account.

The tax bill arrives when you withdraw. At age 62, if you take out $50,000 from your traditional IRA, that $50,000 counts as income for that year. You owe ordinary income tax on it — the same rate you would pay on wages. If you withdraw $50,000 in a year when you have other income, you may move into a higher tax bracket and owe more.

The IRS requires you to start withdrawing from a traditional IRA at age 73 (as of 2023). These are called required minimum distributions, or RMDs. You cannot leave the money untouched to avoid taxes — the government wants its share.

How a Roth IRA works instead

You contribute to a Roth with after-tax dollars. If you earn $60,000 and put $7,000 into a Roth, you still owe income tax on the full $60,000. The $7,000 comes from money you have already paid tax on.

Inside the account, the money grows tax-free. Dividends, capital gains, and interest do not trigger a tax bill each year. At retirement, you withdraw the money with no tax owed — not on the original contribution and not on the growth.

There is no required minimum distribution from a Roth IRA during your lifetime. You can leave the money untouched as long as you want, which makes a Roth useful if you do not need the income in retirement or if you want to pass the account to heirs.

Income limits and who can contribute

Traditional IRAs have no income limit. Anyone with earned income can contribute, regardless of how much they earn. The tax deduction phases out for people covered by a workplace retirement plan, but the contribution itself is always allowed.

Roth IRAs have strict income limits. For 2024, single filers can contribute the full amount only if their modified adjusted gross income is below $146,000. The ability to contribute phases out between $146,000 and $161,000. Married couples filing jointly have higher limits but face the same phase-out structure. If you earn above the limit, you cannot contribute directly to a Roth, though you may be able to use a "backdoor Roth" strategy — a workaround that involves contributing to a traditional IRA and then converting it.

Contribution limits are the same for both account types: $7,000 per year for people under 50, and $8,000 for people 50 and older (as of 2024).

Withdrawal rules and penalties

With a traditional IRA, you can withdraw money before age 59½, but you will owe a 10 percent penalty on top of ordinary income tax. Some exceptions exist — for medical expenses above 7.5 percent of your income, health insurance while unemployed, or a first-time home purchase (up to $10,000 lifetime) — but most early withdrawals cost you.

With a Roth IRA, you can withdraw your contributions at any time, penalty-free. If you put in $50,000 over the years and the account grows to $80,000, you can pull out the $50,000 whenever you want. You cannot touch the $30,000 in earnings without a penalty until age 59½, unless an exception applies.

This flexibility makes a Roth useful as an emergency fund, though it is not the best use of a retirement account. The real advantage is that you can access your own money without the IRS taking a cut.

Tax brackets and which account to choose

The choice between Roth and traditional often comes down to tax brackets. If you are in a high tax bracket now and expect to be in a lower one in retirement, a traditional account saves you money — you deduct at a high rate and pay tax at a low rate. If you are in a low bracket now and expect to be in a higher one later, a Roth locks in the low rate.

Many people in their 20s and 30s choose Roth because they expect to earn more later. People near retirement often choose traditional because they want to reduce their current taxable income. Some people split the difference and contribute to both, though annual contribution limits explore across all IRAs combined.

You can also convert a traditional IRA to a Roth, though you will owe income tax on the amount converted. This strategy makes sense if you expect tax rates to rise or if you have a year with unusually low income.

Employer plans and tax deferral

A 401(k) or similar workplace plan works like a traditional IRA — contributions reduce your taxable income, and withdrawals are taxed as ordinary income. Some employers offer a Roth 401(k) option, which works like a Roth IRA but with higher contribution limits ($23,500 per year for 2024, or $31,000 if you are 50 or older).

Roth 401(k)s have no income limits, making them useful for high earners who cannot contribute to a Roth IRA directly. They also allow larger contributions than a Roth IRA. The tradeoff is that you do not get a tax deduction for the contribution, and you must take required minimum distributions starting at age 73.

Frequently Asked Questions

Can I have both a Roth IRA and a traditional IRA at the same time?

Yes, but your total contributions across all IRAs cannot exceed the annual limit. If you contribute $4,000 to a traditional IRA, you can contribute only $3,000 to a Roth that year (assuming the $7,000 limit for 2024). The limit is per person, not per account.

Do I pay taxes on Roth IRA growth?

No. Once money is in a Roth, all growth — dividends, capital gains, interest — is tax-free. You never pay tax on the earnings, as long as you follow the withdrawal rules and do not take money out before age 59½ (with some exceptions).

What happens to a Roth IRA when I die?

Your heirs inherit the account and can withdraw the money. They will owe income tax on the earnings portion, but not on your original contributions. Roth accounts are often used as a way to pass tax-free wealth to the next generation.

Can I withdraw from a Roth IRA if I lose my job?

You can withdraw your contributions without penalty at any time. If you need to tap the earnings before age 59½, you will owe a 10 percent penalty and income tax, unless you may have access to for an exception like disability or a first-time home purchase.

Is a Roth IRA better than a traditional IRA?

It depends on your current and expected future tax bracket. A Roth is better if you expect to be in a higher bracket later or want tax-free growth. A traditional IRA is better if you want to reduce your taxable income now and expect to be in a lower bracket in retirement.