IRA accounts are taxed differently depending on the type you have and when you withdraw the money

An IRA is not itself taxable—it is a container that holds investments. What gets taxed is the money you take out of it. The tax you owe depends on three things: which type of IRA you own, whether you contributed pre-tax or after-tax dollars, and how old you are when you withdraw.

A traditional IRA lets you deduct contributions from your income in the year you make them, which lowers your taxable income now. When you withdraw money later, the full amount—contributions plus all the growth—is taxed as ordinary income at whatever tax rate applies that year. A Roth IRA works the opposite way: you contribute after-tax dollars (no deduction now), but withdrawals in retirement are tax-free, including all the growth. A SEP IRA or Solo 401(k) for self-employed people follow the traditional model: contributions are deductible, withdrawals are taxed.

The timing of withdrawal matters too. If you withdraw before age 59½, you typically owe income tax plus a 10 percent early withdrawal penalty, with some exceptions (first-time home purchase, medical expenses, disability). After 59½, you owe only the income tax, no penalty. At age 73, the IRS requires you to take Required Minimum Distributions (RMDs) from traditional IRAs each year, and those withdrawals are taxed as income.

Key Takeaways

  • Traditional IRA contributions reduce your taxable income now, but withdrawals are taxed as ordinary income later; Roth IRA contributions are after-tax, but may have access to withdrawals are completely tax-free.
  • Withdrawals before age 59½ from a traditional IRA trigger a 10 percent penalty plus income tax, unless you meet a narrow exception like disability or first-time home purchase.
  • Roth IRA contributions can be withdrawn tax-free at any time, but earnings withdrawn before age 59½ are taxed and penalized unless an exception applies.
  • At age 73, you must begin taking Required Minimum Distributions from traditional IRAs, and those amounts are taxed as ordinary income.
  • The tax rate you pay on IRA withdrawals depends on your total income that year and your tax bracket, not a special IRA rate.

Traditional IRA withdrawals are taxed as ordinary income

When you withdraw money from a traditional IRA, the IRS treats it as income for that year. If you withdraw $10,000, you add $10,000 to your other income (wages, interest, dividends) and pay tax at your marginal rate. If you are in the 22 percent tax bracket, that $10,000 withdrawal costs you $2,200 in federal tax, plus any state income tax your state charges.

This applies to the entire withdrawal—both the money you originally contributed and all the investment gains. The IRS does not separate them. If you contributed $50,000 over 20 years and it grew to $150,000, a $50,000 withdrawal includes $33,333 of growth, and all of it is taxed as income that year.

The exception is if you made non-deductible contributions to your traditional IRA—money you put in without taking a tax deduction because your income was too high or you were covered by a workplace retirement plan. Those dollars are not taxed again when withdrawn. But the IRS requires you to file Form 8606 to track non-deductible contributions, and the calculation is complex if you have multiple IRAs. Most people do not make non-deductible contributions intentionally.

Roth IRA withdrawals follow a different rule: contributions are always tax-free

In a Roth IRA, your contributions come out tax-free at any time, at any age, with no penalty. If you put in $6,500 a year for 10 years, you can withdraw that $65,000 whenever you want without owing tax or penalty. The IRS calls this your basis—the money you actually contributed.

The earnings—the investment growth on top of your contributions—are different. If your $65,000 in contributions grew to $120,000, that $55,000 in earnings is tax-free only if you meet two conditions: you are at least 59½ years old, and you have held the Roth IRA for at least five tax years (not five calendar years; the clock starts January 1 of the year you opened it). If you withdraw earnings before meeting both conditions, you owe income tax on the earnings plus a 10 percent penalty.

This five-year rule applies to each Roth IRA separately if you have more than one, but the IRS counts all your Roth IRAs together when calculating whether you have met the five-year holding period. If you opened your first Roth in 2020, all your Roths satisfy the five-year rule as of January 1, 2025.

Early withdrawal penalties and the exceptions that avoid them

Withdrawing from a traditional IRA before age 59½ costs you a 10 percent penalty on top of income tax, unless you meet one of the IRS exceptions. The main ones are: disability (as defined by the IRS, not your own judgment), death (your beneficiary can withdraw without penalty), medical expenses exceeding 7.5 percent of your adjusted gross income, health insurance premiums while unemployed, first-time home purchase (up to $10,000 lifetime), and higher education expenses for you or your dependents.

There is also the Rule of 55: if you leave your job in the year you turn 55 or later, you can withdraw from that employer's 401(k) or 403(b) without the 10 percent penalty (though you still owe income tax). This does not apply to IRAs, only workplace plans. And there is the Substantially Equal Periodic Payment (SEPP) rule: if you set up a series of equal withdrawals based on your life expectancy, you can avoid the penalty, but you must follow the formula exactly or the penalty applies retroactively to all prior withdrawals.

Roth IRAs have more flexibility: you can withdraw your contributions (not earnings) at any time, at any age, with no tax or penalty. Earnings are penalized if withdrawn early unless an exception applies.

Required Minimum Distributions force taxable withdrawals starting at age 73

The IRS requires you to withdraw a minimum amount from your traditional IRA each year starting at age 73 (this age was 72 until 2022, and it rises to 75 in 2033). The amount is calculated by dividing your IRA balance on December 31 of the prior year by a life expectancy factor published by the IRS. For a 73-year-old with a $500,000 IRA, the RMD might be roughly $18,000 to $20,000, depending on the exact factor.

Every dollar of the RMD is taxed as ordinary income. You cannot avoid it by not spending the money; the IRS requires the withdrawal to happen, and it counts as income whether you use it or reinvest it. If you fail to take the full RMD, the penalty is 25 percent of the shortfall (reduced to 10 percent if you correct it within two years). If you are still working and do not own more than 5 percent of the company, you may be able to delay RMDs from that employer's 401(k), but not from IRAs.

Roth IRAs do not require RMDs during the account holder's lifetime. Your beneficiaries will have to take distributions after you die, but you do not have to withdraw anything while you are alive.

State income tax and how it applies to IRA withdrawals

Federal income tax is only part of the bill. Most states also tax IRA withdrawals as ordinary income. A few states—including Pennsylvania, Illinois, and Mississippi—do not tax retirement income, including IRA withdrawals, so residents of those states owe only federal tax. Most other states tax the full withdrawal amount at their state income tax rate, which ranges from roughly 3 percent to over 13 percent depending on the state and your income level.

Some states offer partial exemptions for retirement income if you are over a certain age (often 59½ or 62), but the rules vary widely. If you are planning to retire in a different state than where you worked, the state tax treatment of your IRA can be significant. A $50,000 withdrawal in a state with no retirement income tax costs you nothing in state tax; the same withdrawal in a state with a 10 percent rate costs $5,000.

Backdoor Roth conversions and the pro-rata rule

A backdoor Roth is a strategy where you contribute to a traditional IRA and then immediately convert it to a Roth IRA, moving money into a tax-free account when your income is too high to contribute directly to a Roth. The conversion itself is a taxable event: you owe income tax on any pre-tax money in the traditional IRA at the time of conversion.

The pro-rata rule complicates this. If you have any pre-tax money in any traditional IRA—including SEP IRAs, SIMPLE IRAs, or old 401(k)s you rolled over—the IRS treats all your traditional IRAs as one pool. If you convert $7,000 to a Roth but have $93,000 in pre-tax traditional IRAs, the IRS calculates that 93 percent of the conversion is pre-tax money, so you owe tax on $6,510 of the $7,000 conversion. This can make backdoor Roth conversions expensive or impossible if you have significant pre-tax retirement savings.

Frequently Asked Questions

Do I owe taxes on IRA interest and investment gains while the money is still in the account?

No. Interest, dividends, and capital gains inside an IRA are not taxed each year. That is the main benefit of an IRA—your money grows tax-deferred. You owe tax only when you withdraw the money. In a Roth, you owe nothing even then.

What happens if I inherit an IRA from someone else?

Inherited traditional IRAs are taxed to you as income when you withdraw. Inherited Roth IRAs are tax-free if the original owner had held it for five years; otherwise earnings are taxed. The rules changed in 2023, and most beneficiaries must now empty inherited IRAs within 10 years. Consult a tax professional, as the rules depend on your relationship to the deceased.

Can I deduct IRA contributions on my taxes?

Traditional IRA contributions may be deductible, but only if you do not have access to a workplace retirement plan, or if your income is below certain limits. Those limits change yearly. Roth IRA contributions are never deductible. Check the IRS website or a tax professional to see if your contribution is deductible based on your income and coverage by a workplace plan.

If I convert a traditional IRA to a Roth, do I owe taxes on the conversion?

Yes. A Roth conversion is a taxable event. You owe income tax on the full amount converted, calculated as if it were a withdrawal. If you convert $100,000, you add $100,000 to your income that year and pay tax at your marginal rate. The pro-rata rule applies if you have other pre-tax IRAs.

What is the difference between a Roth conversion and a backdoor Roth?

A backdoor Roth is a specific strategy: contribute to a traditional IRA (non-deductible), then immediately convert to a Roth. A Roth conversion is the broader action of moving money from a traditional IRA to a Roth. All backdoor Roths are conversions, but not all conversions are backdoor Roths.