You pay taxes on most IRA withdrawals, but not on the money you put in

Whether you owe taxes on your IRA depends on what type of account you have and when you take money out. With a traditional IRA, you pay income tax on withdrawals because the money you contributed was never taxed. With a Roth IRA, you pay no tax on withdrawals in retirement because you already paid tax on the money going in. The tax bill arrives when you withdraw, not when you contribute — with one exception for traditional IRAs, where some contributions may be tax-deductible.

The IRS treats these accounts differently because they were designed to encourage different savings patterns. Understanding which type you have and what the rules are for your situation will tell you exactly when and how much you owe.

Key Takeaways

  • Traditional IRA contributions may be tax-deductible in the year you make them, but withdrawals are taxed as ordinary income.
  • Roth IRA contributions are made with after-tax money, so withdrawals in retirement are tax-free if the account is at least five years old.
  • You must begin taking withdrawals from a traditional IRA at age 73, and those withdrawals are fully taxable.
  • Withdrawals before age 59½ from either account type usually trigger a 10 percent penalty on top of income tax, with limited exceptions.
  • If you have both traditional and Roth IRAs, the IRS treats all your traditional IRAs as one account for tax purposes when you withdraw.

Traditional IRA withdrawals are taxed as income

When you withdraw money from a traditional IRA, the full amount is taxed as ordinary income in the year you take it out. This applies whether you contributed $5,000 or $50,000. The IRS taxes it the same way it taxes wages from your job — at your regular income tax rate for that year.

The reason is that traditional IRA contributions were either tax-deductible when you made them or they were made with pre-tax money from your employer. Either way, the money was never taxed before it went into the account. The tax was straightforward delayed until you withdrew it.

If you contributed to a traditional IRA and your income was below certain thresholds, your contribution may have been tax-deductible. If you were covered by a workplace retirement plan (like a 401(k)), the income limits are lower. If you were not covered by a workplace plan, you could deduct the full contribution. You can find your specific limits on the IRS website or by checking your tax return from the year you contributed.

Roth IRA withdrawals are tax-free in retirement

Roth IRA withdrawals are not taxed if you follow the rules: the account must be at least five years old, and you must be at least 59½ years old when you withdraw. If both conditions are met, you owe nothing to the IRS on the withdrawal, no matter how much the account has grown.

This is the opposite of a traditional IRA because you paid income tax on the money before you put it in. The Roth was designed to let your money grow tax-free and come out tax-free, as a reward for paying tax upfront.

If you withdraw before the account is five years old or before you turn 59½, the earnings (the growth) are taxed as income and may be subject to a 10 percent penalty. Your original contributions can always come out tax-free, but the gains cannot.

Early withdrawals usually trigger a 10 percent penalty

If you withdraw from either a traditional or Roth IRA before age 59½, you typically owe a 10 percent penalty on top of income tax. This penalty is separate from the tax itself — it is an additional cost for breaking the rules early.

Some situations allow you to avoid the penalty. You can withdraw without penalty from a traditional IRA if you are disabled, if you use the money for may have access to medical expenses, if you are paying health insurance premiums while unemployed, or if you take substantially equal periodic payments based on your life expectancy. For Roth IRAs, you can also withdraw your contributions (not earnings) at any time without penalty, and you can withdraw for a first-time home purchase up to $10,000 lifetime.

The penalty applies to the amount withdrawn, not to your entire account. If you withdraw $8,000 early, the penalty is 10 percent of $8,000. The tax is calculated on the same amount, at your regular income tax rate.

Required minimum distributions are always taxable

Starting at age 73, the IRS requires you to withdraw a minimum amount from your traditional IRA each year. These are called required minimum distributions, or RMDs. The amount is calculated based on your age and the balance in your account at the end of the previous year. You must take the withdrawal whether you need the money or not.

Every dollar of an RMD from a traditional IRA is taxed as ordinary income. If you do not take the required amount, you owe a penalty of 25 percent of the shortfall (reduced to 10 percent if you correct it within two years). This penalty is in addition to the income tax you still owe on the amount you should have withdrawn.

Roth IRAs do not have RMDs during your lifetime, which is one reason some people prefer them. Your heirs will have RMDs after you pass away, but you do not.

Mixing traditional and Roth IRAs affects your tax bill

If you have both a traditional IRA and a Roth IRA, the IRS treats all your traditional IRAs as a single account for tax purposes when you withdraw. This matters if you are trying to withdraw only from your Roth to avoid taxes.

For example, if you have a traditional IRA with $50,000 and a Roth IRA with $20,000, and you withdraw $10,000 from the Roth, the IRS does not let you treat it as coming entirely from your contributions. Instead, it calculates what percentage of your total IRA balance is in traditional accounts (about 71 percent in this case) and taxes 71 percent of your withdrawal. This is called the pro-rata rule.

The pro-rata rule can make it expensive to withdraw from a Roth if you also have a large traditional IRA. Some people convert their traditional IRA to a Roth to avoid this problem, but the conversion itself is a taxable event.

SEP-IRAs and straightforward IRAs follow traditional IRA rules

If you are self-employed or own a small business, you may have a SEP-IRA or straightforward IRA instead of a traditional or Roth. Both are taxed like traditional IRAs: contributions may be tax-deductible, and withdrawals are taxed as ordinary income.

SEP-IRAs allow larger contributions than regular IRAs — up to 25 percent of your net self-employment income or a set dollar limit, whichever is smaller. straightforward IRAs are for businesses with 100 or fewer employees and have lower contribution limits. Both have the same RMD rules as traditional IRAs, and both charge the 10 percent penalty for early withdrawal with the same exceptions.

If you have questions about whether your specific plan is a SEP or straightforward, check the paperwork from your plan administrator or ask your accountant.

Frequently Asked Questions

Do I owe taxes on the money I contribute to my IRA?

Not directly. Traditional IRA contributions may be tax-deductible in the year you make them, which means you do not pay income tax on that money that year. Roth contributions are made with after-tax money, so you have already paid tax on them. The tax on traditional IRAs is deferred until you withdraw.

What if I have both a traditional and Roth IRA and I only want to withdraw from the Roth?

The IRS pro-rata rule means you cannot isolate your Roth withdrawal. A portion of it will be treated as coming from your traditional IRA and will be taxable. The percentage is based on the total balance across all your traditional IRAs compared to your total IRA balance.

Can I withdraw from my IRA without paying the 10 percent penalty before age 59½?

Yes, in specific situations. You can avoid the penalty if you are disabled, if you use the money for may have access to medical expenses or health insurance while unemployed, or if you take substantially equal periodic payments. Roth IRA holders can also withdraw contributions at any time and up to $10,000 for a first-time home purchase.

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

You owe a penalty of 25 percent of the amount you should have withdrawn (reduced to 10 percent if you correct it within two years). You also still owe income tax on the amount that should have been withdrawn, even though you did not take it.

Are inherited IRAs taxed the same way?

No. Inherited traditional IRAs are taxed to the person who inherits them, not to the original account owner. Inherited Roth IRAs are tax-free if the original owner had the account for at least five years. The rules for how long you must keep an inherited IRA depend on your relationship to the original owner and when they died.