When Do You Pay Taxes on a Roth IRA?

Taxes for income contributions to a Roth IRA are paid before the money goes into the account. This means that the money used to fund a Roth IRA must come from income that already has income tax taken out. The benefit to this is that the money in the Roth IRA can then be withdrawn at any time, without taking an additional tax hit. However, withdrawing any interest made on the money in the Roth will receive a penalty.

The best way to understand a Roth IRA is to compare it to a traditional IRA. IRA stands for Individual Retirement Account. The money saved should be used for expenses after retiring from work. For this reason, there are many tax benefits to putting money into IRAs.

Traditional IRA

In a traditional IRA, money is deposited into the account before any taxes are taken out. To withdraw the money, a person must have reached retirement age. At that point, taxes are taken out of the money. Any money withdrawn before retirement age will have higher tax penalties.

Roth IRA

In a Roth IRA, contributions can only be made with post tax dollars. By doing this, the money in a Roth IRA will not incur any additional tax penalties no matter when it is withdrawn in the future. However, interest earned on principle contributions will still be subject to taxes. Because you pay taxes on Roth IRAs before putting money in, Roth IRAs can also be a substitute college savings plan. A special provision allows for money to be withdrawn for higher education. If a child does not attend college then the money remains part of the retirement account.

A Roth IRA allows for additional money to be saved for retirement on top of any other retirement plans already in place. This type of account can be opened in a bank or through a brokerage firm.

Roth IRAs do have maximum contributions per year, though. For 2010, the maximum contribution per person is $5000 for anyone aged 49 and under. Persons aged 50 and older may contribute $6000 per year. Income caps do apply to eligible contributions. In addition, any contributions not made in one year cannot be applied to the next year.