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Withdrawals on earnings from a Roth IRA don’t count as income, but only if you make what the IRS deems as qualified distributions. If you follow IRS rules, earnings grow tax-free, and you don’t pay taxes on withdrawals either, which are among the main benefits of this type of retirement account.
Non-qualified distributions count as income and are subject to taxes and potential penalties, too. The income from a non-qualified distribution also impacts your modified adjusted gross income (MAGI), which the IRS uses to determine if you are eligible to contribute to a Roth IRA. In general, high-income earners cannot.
Key Takeaways
- Earnings from a Roth IRA don’t count as income as long as withdrawals are considered qualified.
- Typically, you need to be at least 59½ and the account at least five years old for a distribution to count as qualified, but there are exceptions.
- If you take a non-qualified distribution, it counts as taxable income, and you might also have to pay a penalty.
- Non-qualified distributions also impact your MAGI, which the IRS uses to determine if you are eligible to contribute to a Roth.
The Basics of Roth IRAs
Roth IRAs offer a tax-advantaged way to save for retirement. Unlike a traditional IRA, Roth IRA contributions are made with after-tax dollars and are not deductible.
Instead, the tax benefit is realized on the backend with tax-free withdrawals. Because contributions are made with after-tax dollars, you can withdraw them at any time, tax and penalty-free, and they won’t count as income. The maximum you can contribute to a Roth IRA in 2021 and 2022 is $6,000. If you’re 50 and older, you’re eligible to contribute an additional $1,000.
However, withdrawals on earnings from these investments are taxed differently. Earnings on investments within a Roth IRA are not subject to income tax or included in the account owner’s income. Instead, they accumulate on a tax-deferred basis and are tax-free when withdrawn from the Roth if the distribution is qualified. If the distribution is not qualified, it counts as income, you’ll owe taxes, and may also be subject to a 10% early withdrawal penalty.
Roth IRAs and Qualified Distributions
Distributions on earnings from a Roth IRA count as qualified if you are age 59½ and older and you have had a Roth IRA account for at least five years, which is known as the “5-year rule.” The 5-year rule also applies to funds converted from a traditional IRA to a Roth IRA.
If you’re 59½ or over and don’t meet the 5-year rule, distributions count as income, and you’ll pay taxes on them but not the 10% early withdrawal penalty.
There are exceptions to the qualified distribution rule. You can make a withdrawal tax and penalty-free if you are younger than 59½ and have had the account for at least five years if:
- You are permanently disabled.
- The withdrawal is used to purchase a first home ($10,000 limit).
- If you pass away and the withdrawal is made by a beneficiary inheriting the Roth.
Non-Qualified Distributions and MAGI
Taking a non-qualified distribution can also affect your eligibility to contribute to a Roth IRA. These accounts are subject to income limits. If you take a non-qualified distribution, earnings (not contributions) will be included in your MAGI, which the IRS uses to determine Roth IRA eligibility.
In 2021, individuals with a MAGI of $140,000 or less are permitted to contribute the maximum to a Roth IRA. The phase-out for singles starts at $125,000. The MAGI limit is $208,000, with a phase-out starting at $198,000 if you are married and filing jointly. For 2022, individuals with a MAGI of $144,000 or less can contribute to a Roth IRA, with the phase-out for singles starting at $129,000. For married couples filing jointly, the MAGI limit is $214,000, with a phase-out starting at $204,000.
The Bottom Line
If you have a Roth IRA, earnings you withdraw don’t count as income or impact your MAGI as long as you are 59½, and you have had a Roth account for at least five years. If not, you’ll owe taxes and may have to pay a 10% early withdrawal penalty, too.
Keep in mind that you can withdraw contributions at any time and age, penalty and tax-free, and it won’t count as income.
What the Experts Say
Advisor Insight
Joe Allaria, CFP®
CarsonAllaria Wealth Management, Glen Carbon, IL
The easy answer is that earnings from a Roth IRA do not count towards income. If you keep the earnings within the account, they definitely are not taxable.
And if you withdraw them? Generally, they still do not count as income—unless the withdrawal is considered a non-qualified distribution. In that case, the earnings could be taxable. (The IRS website, IRS.gov, explains what defines qualified vs. non-qualified Roth IRA distributions.)
Bear in mind, though, that at no point are you ever forced to take distributions from a Roth IRA, unlike a traditional IRA, where required minimum distributions begin the year (or the year following the year) in which you turn 72.
