How does a Roth IRA work?
Last updated August 2026
Short answer
Most retirement accounts give you a tax break now and send the bill later. A Roth IRA does the opposite, and that single reversal is the whole idea. It makes the account unusually flexible, unusually simple at the end of your life, and slightly painful at the start. Here is how the mechanism actually works.
The mechanism: pay tax once, at the front
Say you earn $60,000 and put $6,000 into a Roth IRA. You still pay income tax on the full $60,000. Nothing about your tax return changes. That $6,000 goes into the account having already been taxed.
From that point on, the account is invisible to the tax system. Dividends are not taxed in the year you receive them. Selling a fund at a gain inside the account triggers nothing. You get no 1099 for activity inside a Roth. Thirty years later, when the account is worth far more than you put in, you can take all of it out and owe nothing, provided you meet the two conditions below.
A Traditional IRA reverses that. You deduct the contribution now, the account grows untaxed, and every dollar you withdraw in retirement is taxed as ordinary income. Same account shape, opposite tax timing.
The two conditions for tax-free withdrawals
A withdrawal is qualified, meaning fully tax free, when both of these are true:
1. You are 59 and a half or older. There are exceptions, including death, disability, and up to $10,000 toward a first home.
2. Five tax years have passed since your first Roth contribution. This is the five-year rule, and it trips people up because it is not five years from the deposit. The clock starts on January 1 of the tax year the contribution counts for. Contribute in April 2026 for tax year 2025 and your clock started in January 2025. It is also one clock per person across all your Roth IRAs, not a new clock for each account.
Miss either condition and you have a non-qualified withdrawal, which is where the ordering rules matter.
Contributions come out first, and that is the flexible part
The IRS treats Roth withdrawals in a fixed order: your contributions come out first, then converted amounts, then earnings. Because you already paid tax on contributions, taking them back out is never taxed and never penalized, at any age, for any reason.
If you have put in $30,000 over the years and the account is now worth $48,000, the first $30,000 you withdraw is your own money coming back. Only once you go past that are you touching the $18,000 of growth, which is where tax and the 10% early withdrawal penalty can apply.
This is why a Roth is often described as doubling as an emergency reserve. It is a real feature, and it is also a trap: money you pull out cannot be put back beyond that year's contribution limit, so a withdrawal permanently costs you the tax-free growth that money would have produced.
No required minimum distributions
Traditional IRAs and 401(k)s force you to start withdrawing at a set age whether you need the money or not. Roth IRAs do not. You can leave the account untouched for your entire life, which makes it the account people most often intend to pass on. Heirs inherit it with the tax already paid, though they generally have to draw it down within ten years.
What it costs to open and run
A Roth IRA is a wrapper, not an investment. Opening one at a mainstream brokerage costs nothing and there is usually no minimum. What you hold inside it, index funds, ETFs, individual stocks, is entirely your choice, and that choice is what determines your return.
The most common and most expensive mistake is contributing and then leaving the cash uninvested. The money sits there earning almost nothing while you assume it is working. Funding the account and investing the account are two separate actions.
Try it in Walnut
Walnut connects to the brokerage where your Roth IRA already lives and reads what is actually in it, so you can see whether the money you contributed is invested and how it is allocated.
Common mistakes
Assuming you are eligible. Roth contributions phase out at higher incomes. For 2026 the range is $153,000 to $168,000 for single filers and $242,000 to $252,000 for married couples filing jointly.
Over-contributing. Putting in more than the annual limit, or more than you earned, triggers a 6% penalty for every year the excess stays in the account.
Starting the five-year clock late. If you think you may want a Roth eventually, a small contribution now starts the clock for every Roth you will ever hold.
Sources
Contribution and income limits are from IRS Notice 2025-67. Withdrawal ordering, the five-year rule and the exceptions are set out in IRS Publication 590-B. Walnut is informational and is not an investment adviser. This guide is educational and not personalized tax or investment advice; anything with a tax consequence is worth confirming with a tax professional.
FAQ
How does a Roth IRA actually work?
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You contribute money you have already paid income tax on. It is invested inside the account, where it grows without being taxed each year. Once you are 59 and a half and the account has been open five years, everything you take out, contributions and all the growth on top, comes out completely tax free.
Can I take money out of a Roth IRA before retirement?
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You can withdraw your own contributions at any age, for any reason, with no tax and no penalty, because you already paid tax on that money. Earnings are different. Pulling earnings out before 59 and a half usually means income tax plus a 10% penalty unless an exception applies.
What is the Roth IRA five-year rule?
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Your earnings are only tax free once five tax years have passed since your first contribution to any Roth IRA. The clock starts on January 1 of the year of that first contribution, so a contribution made in April 2026 for tax year 2025 starts the clock at January 2025. It is one clock per person, not per account.
Is a Roth IRA better than a Traditional IRA?
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It depends on when you would rather pay the tax. A Roth is generally better if you expect your tax rate in retirement to be as high as or higher than it is now, which often favors younger and lower-earning savers. A Traditional IRA gives you the deduction today instead. Many people end up holding both.