Are Dividends Taxed in a Roth IRA?

Dividends received from stocks, mutual funds, or exchange-traded funds held inside a Roth IRA are not taxed when they are paid out or reinvested. This tax treatment allows the full value of the dividend to be put back to work, enhancing the power of compounding within the account. The tax considerations for a Roth IRA arise not when earnings are generated, but when money is withdrawn from the account.

Tax Treatment of Dividends Inside the Account

All earnings generated within the account, which includes dividends, interest, and capital gains, accumulate without being subject to annual taxation. This means that unlike a standard taxable brokerage account where you would receive a Form 1099-DIV and owe taxes on dividend income for that year, no such tax liability is created for dividends that remain inside the Roth IRA.

The tax classification of dividends as “qualified” or “non-qualified,” which determines the tax rate in a taxable account, is irrelevant for investments held within a Roth IRA. Since no taxes are assessed on the earnings as they accrue, this distinction has no impact. Investors can utilize dividend reinvestment plans (DRIPs) to automatically purchase more shares using the dividend payments, and these transactions do not trigger a taxable event within the account.

Taxation of Qualified Roth IRA Withdrawals

The benefit of a Roth IRA is the ability to take completely tax-free withdrawals in retirement, provided the distributions are “qualified.” For a withdrawal to be considered qualified, it must meet two conditions set by the IRS. If these conditions are satisfied, the entire withdrawal amount, which includes all original contributions and the accumulated dividends and other earnings, is received free from federal income tax.

The first condition is the five-year rule. The Roth IRA must have been open for a minimum of five tax years before any earnings can be withdrawn tax-free. This five-year clock begins on January 1 of the tax year for which the first contribution was made, regardless of the actual date of the deposit. For example, a first-time contribution made in April 2025 for the 2024 tax year starts the clock on January 1, 2024.

The second condition relates to the account holder’s age or status. The owner must be at least 59½ years old at the time of the withdrawal. The IRS also permits qualified distributions before this age if the withdrawal is due to the account holder becoming totally and permanently disabled or if the funds are used for a qualified first-time home purchase, which has a lifetime limit of $10,000 from an IRA.

Tax Consequences of Non-Qualified Withdrawals

When a withdrawal does not meet the criteria to be a qualified distribution, it is classified as non-qualified. The IRS has specific ordering rules that dictate which funds are considered to be withdrawn first. Any non-qualified distribution from a Roth IRA must be reported to the IRS using Form 8606.

Under the IRS ordering rules, distributions are taken from the account in a specific sequence. The first money to be withdrawn is always your direct contributions. Since contributions to a Roth IRA are made with after-tax dollars, they can be withdrawn at any time, at any age, for any reason, completely free of both taxes and penalties. After all contributions have been withdrawn, the next funds to come out are any amounts that were converted from other retirement accounts, like a Traditional IRA.

Only after all contributions and converted amounts have been distributed are the investment earnings withdrawn. This earnings portion, which includes all accumulated dividends, is the only part of a non-qualified withdrawal that is subject to taxation. These earnings are taxed as ordinary income at the account holder’s current tax rate and are also subject to a 10% early withdrawal penalty if the owner is under age 59½. For instance, if you contributed $20,000 and have $5,000 in earnings, a $22,000 non-qualified withdrawal would consist of your $20,000 tax-free contribution return and $2,000 of taxable and penalized earnings.

Certain situations provide an exception to the 10% penalty on early withdrawals of earnings, such as using the funds for qualified higher education expenses or for certain medical costs exceeding a specific percentage of your adjusted gross income. These exceptions only waive the 10% penalty. The earnings portion of the withdrawal is still considered taxable income in the year it is received.