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Capital Gains Tax for Roth IRAs

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When you’re saving for retirement, there are a variety of accounts you could use. The Roth IRA, or individual retirement account, is one of those options. Roth IRAs offer more investment flexibility, as well as their own tax benefits. Understanding how a Roth IRA is taxed is essential to taking full advantage of it. It’s important to understand how Roth IRAs are taxed, especially when it comes to gains and withdrawals. You can work with a financial advisor who can help set your retirement and tax planning strategies up in ways that can benefit you. 

How Roth IRAs Are Taxed

Roth IRAs aren’t taxed on capital gains like so many investments that you may be used to. They share this in common with traditional IRAs. This applies to both short-term and long-term capital gains and it doesn’t matter if you keep the money in the account or if you withdraw it. The ability to avoid capital gains is one of the major perks of using an IRA.

A Roth IRA is what’s known as a post-tax retirement savings account. This means that, unlike a 401(k) or traditional IRA that is taxed when you withdraw, a Roth IRA uses money that’s already been taxed. In other words, you pay the income tax on your money and then invest it. When it comes time to withdraw, as long as you’re 59 1/2 or older, you won’t pay taxes or fees on it.

What Should You Invest in With a Roth IRA?

roth ira taxed on gains

Along with the tax benefits, another benefit of the Roth IRA is the options you have when looking to invest. You can invest your Roth IRA money in many places, including:

One popular method of growing your retirement account is to use your Roth IRA to invest in dividend stocks. These stocks regularly pay out money to investors and you can reinvest that money in your IRA without it counting toward your contribution limit. This makes dividend stock investments a desirable way to maximize your retirement savings.

You should also regularly rebalance your IRA with a focus on growth. Because a Roth IRA isn’t taxed on withdrawals or returns, you can take full advantage by investing in actively managed funds. Without having to worry about capital gains tax or taxes on returns, you can actively focus on getting the most return on your investment.

Roth IRA vs. Other Retirement Accounts

So, we’ve talked largely about the advantages Roth IRAs have. Because they use already taxed money, you don’t have to pay taxes upon withdrawal, like you would with a traditional IRA or an employer-sponsored plan, like a 401(k).

While Roth IRAs have many advantages, they also have some drawbacks. For instance, unlike 401(k)s, 403(b)s and 457s, Roth IRAs have a much lower contribution limit. For the tax year 2023, 401(k)s, 403(b)s and 457s have a limit of $22,500 ($23,000 in 2024), whereas IRAs are limited to $6,500. That increases to $7,000 in 2024.

On top of contribution limits, another major drawback is that Roth IRAs don’t lower your taxable income. You see, one of the benefits of retirement accounts that use pre-tax money is that contributions lower your taxable income in the year they’re made. So, if you make $80,000, but contribute $22,500 to your 401(k), you’re only taxed on $57,500.

Another drawback of Roth IRAs is that you may not be able to use them if you make too much money. For the tax year 2023, your modified adjusted gross income (MAGI) must be under $153,000 if filing singly or $228,000 if married and filing jointly. These increase to $161,000 and $240,000 in 2024.

Bottom Line

roth ira taxed on gains

Roth IRAs aren’t taxed on capital gains. In fact, they aren’t taxed on any returns. Because all of the money you invested has already been taxed, you can invest without worrying about capital gains. Along with that, Roth IRAs offer plenty of flexibility when it comes to investing, letting you stash your money in individual stocks, funds, CDs and even real estate.

Of course, there are drawbacks. While you can avoid capital gains, there are contribution limits to IRAs. Plus, you won’t be able to deduct your savings contributions from your income taxes on the applicable year. Utilizing all of the retirement savings options you have can help you meet your goals. Follow our tips to help you get ready.

Tips for Retirement Planning

  • According to industry experts, if you work with a financial advisor, you’re likely to save twice as much for retirement. An advisor can help you create a financial plan and help you get on track for your retirement goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • When you retire, you want to retire comfortably. Use SmartAsset’s retirement calculator to estimate your retirement goals and determine how much you need to save
  • If your employer offers 401(k) matching, you need to take full advantage of it. SmartAsset’s 401(k) calculator can help you figure out how much you’ll have based on your annual contribution and your employer’s matches.

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