Is an IRA a Taxable Account? Roth vs. Traditional

An Individual Retirement Account (IRA) serves as a retirement savings vehicle, offering tax advantages. Its tax treatment depends on the specific type of IRA established. These accounts come with distinct rules concerning contributions, investment growth, and withdrawals, each carrying unique tax implications. Understanding these differences is essential for optimizing your retirement savings strategy.

Tax Treatment of Traditional IRAs

Contributions to a Traditional IRA may offer an immediate tax benefit, as they can be tax-deductible in the year they are made. This deduction reduces your current taxable income, potentially lowering your tax liability. Deductibility depends on your modified adjusted gross income (MAGI), tax filing status, and whether you are covered by a workplace retirement plan. For instance, in 2025, a single filer covered by a workplace plan with a MAGI of $79,000 or less may fully deduct contributions, with partial deductions up to $89,000.

If you are not covered by a workplace retirement plan, Traditional IRA contributions are generally fully deductible, regardless of income. If your spouse is covered by a workplace plan and you file jointly, your deduction may be limited by your combined MAGI. For 2025, married couples filing jointly with one spouse covered by a workplace plan may fully deduct contributions if their MAGI is $126,000 or less, with a phase-out up to $146,000.

Investments within a Traditional IRA grow on a tax-deferred basis. This means earnings, such as interest or capital gains, are not taxed annually. Instead, taxes are postponed until you withdraw the funds in retirement. This deferral allows your investments to compound more effectively over time, as gains are reinvested without immediate tax obligations.

Withdrawals from a Traditional IRA in retirement are generally taxed as ordinary income. Since contributions may have been tax-deductible and earnings grew tax-deferred, the entire amount withdrawn is subject to income tax at your then-current marginal rate. If you made non-deductible contributions, a portion of your withdrawals will be tax-free, representing the return of your after-tax contributions.

Tax Treatment of Roth IRAs

Contributions to a Roth IRA are made with after-tax dollars, meaning they are not tax-deductible in the year they are contributed. There is no immediate tax reduction for making a Roth contribution. The maximum amount you can contribute to a Roth IRA for 2025 is $7,000, or $8,000 if you are age 50 or older.

Eligibility to contribute directly to a Roth IRA is subject to income limitations based on your modified adjusted gross income (MAGI). For 2025, single filers can make a full contribution if their MAGI is less than $150,000, and married couples filing jointly if their MAGI is less than $236,000. If your income falls within specific phase-out ranges, your ability to contribute may be reduced or eliminated. For single filers, this range is $150,000-$165,000, and for joint filers, $236,000-$246,000.

A significant advantage of the Roth IRA is that earnings and gains within the account grow entirely tax-free. This means that as your investments increase in value, you will not owe any taxes on that growth, unlike the tax-deferred growth in a Traditional IRA.

Qualified withdrawals from a Roth IRA in retirement are completely tax-free, including original contributions and accumulated earnings. To be qualified, the account must have been open for at least five years from the first contribution, and you must be at least age 59½. Other conditions for tax-free withdrawals include disability or using up to $10,000 for a first-time home purchase.

Comparing Traditional and Roth IRA Tax Treatment

The primary distinction between Traditional and Roth IRAs lies in when you receive the tax benefit. Traditional IRAs offer a potential upfront tax deduction on contributions, reducing your current taxable income. You pay taxes on these funds later, during retirement withdrawals.

Conversely, Roth IRAs provide no upfront tax deduction, as contributions are made with after-tax dollars. However, all qualified withdrawals, including contributions and investment earnings, are entirely tax-free in retirement. Investment growth also differs: Traditional IRA assets grow tax-deferred, while Roth IRA assets grow completely tax-free. This fundamental difference in tax timing impacts which IRA type may be more advantageous based on your current versus expected retirement income.

Additional Tax Rules for IRAs

Individual Retirement Accounts are subject to specific rules regarding distributions, particularly concerning early withdrawals and required minimum distributions (RMDs). Generally, if you withdraw funds from an IRA before reaching age 59½, the distribution may be subject to a 10% additional tax, often referred to as an early withdrawal penalty. This penalty applies to the taxable portion of a Traditional IRA withdrawal and to the earnings portion of a non-qualified Roth IRA distribution.

There are several exceptions to this 10% penalty, allowing penalty-free withdrawals, though regular income tax may still apply.
Distributions for unreimbursed medical expenses exceeding a certain percentage of adjusted gross income.
Qualified higher education expenses.
Up to $10,000 for a first-time home purchase.
Distributions due to death or total and permanent disability.
Health insurance premiums while unemployed.

Required Minimum Distributions (RMDs) are another tax rule impacting IRAs, primarily Traditional IRAs. These rules mandate that account owners begin taking distributions from their Traditional IRA once they reach a certain age. The SECURE Act 2.0 increased the age for beginning RMDs to 73 for individuals turning 73 after December 31, 2022. This age will further increase to 75 for individuals turning 74 after December 31, 2032.

The purpose of RMDs is to ensure tax-deferred savings are eventually taxed. Failure to take the full RMD by the deadline can result in a 25% excise tax on the amount not withdrawn, which can be reduced to 10% if corrected within two years. Original Roth IRA owners are not subject to RMDs during their lifetime, providing greater flexibility in leaving funds to beneficiaries.