In general, if you follow certain rules, money contributed to a Roth account should never again be taxed.
You can withdraw contributions to a Roth IRA at any time, but if you withdraw earnings before meeting certain requirements, you may owe taxes and a penalty.
Rules around early and penalty-free withdrawals from a Roth 401(k) are more complicated.
Whether you have a Roth 401(k) through your employer or a Roth IRA on your own, these accounts are a great way to save for retirement. While you pay tax on the money you put into these accounts in the year that you make your contributions, the money will grow tax–free, and you typically won’t owe tax when you withdraw funds in retirement. This is a key difference between Roth accounts and traditional IRA or 401(k) accounts—which offer tax breaks when you contribute, but require you to pay tax when you withdraw funds in retirement.
So does that mean that money you put into a Roth account will never be taxed again? In theory (and as long as you follow some rules), the answer is yes. But below we delve into the question a bit more.
And, before we get to the question, it’s important to point out that because of the tax advantages they offer, there are limits on what you are able to contribute to Roth accounts. For IRA’s (including Roth IRAs), in 2023 you cannot contribute more than $6,500 ($7,500 if you’re 50 or older) in a single year. Additionally, depending on your situation, you may only be able to contribute a reduced amount or even not contribute at all. The limit for 401(k) contributions is $22,500 ($30,000 if you’re 50 or older). Because the rules can be somewhat complicated, it can be a good idea to work with a tax advisor, especially when contributing to a Roth IRA.
Could Congress change the law and tax funds currently in Roth accounts in the future?
Anything’s possible, and even if Congress were to change the law, it’s possible that funds currently in Roth accounts would be grandfathered into their tax status, with any changes on accounts taking place moving forward.
Is there any other way funds in a Roth account could be taxed again?
Yes, there are ways you could owe tax on your Roth funds in the future. These typically involve withdrawing funds prior to retirement.
Withdrawals from a Roth IRA
With a Roth IRA, you can typically withdraw your regular contributions at any time without owing taxes or a penalty. However, if you withdraw any earnings before you reach the age of 59½ or prior to holding your account for five years, you will typically owe a 10 percent penalty on top of taxes on the earnings.
After you turn 59½ and have held your account for at least five years, you can withdraw your funds tax- and penalty-free.
Withdrawals from a Roth 401(k)
Withdrawals from a Roth 401(k) are a little more complicated. With a Roth 401(k), you can take tax-free distributions once you are 59½ (and as long as you’ve been contributing to the account for at least five years). These are known as “qualified” distributions. There are also a number of very specific “hardship” reasons (like medical, funeral or educational expenses) for which you may be able to take penalty-free withdrawals prior to being able to take qualified distributions if your plan allows it.
It is still possible to withdraw Roth funds from a 401(k) without meeting either of the two conditions above. However, this is where it gets complicated. Unlike a Roth IRA, from which you can just withdraw your contributions, with a Roth 401(k), distributions must include prorated contributions and earnings. Let’s say you have $100,000 in a Roth 401(k), $80,000 of which are contributions and $20,000 are earnings (80 percent of the account is contributions and 20 percent is earnings). With any withdrawal, you’ll owe tax on 20 percent of the amount you take out. That means if you withdraw $10,000 without meeting the conditions, you’ll owe taxes and a penalty on $2,000, or 20 percent of your withdrawal.
Should you withdraw Roth funds before retirement?
Everyone’s situation is certainly unique, and there may be good reasons a person would find it necessary to withdraw funds from a Roth account prior to retirement. But this should typically be a last resort, as these funds are intended for retirement. That’s a key reason the government charges a penalty on top of taxes for early withdrawals. Allowing the money in these accounts to grow tax-free can help to amplify your returns over time, which could make your money go further in your retirement. A Northwestern Mutual financial advisor can help you look at your options for accessing funds and show you how different options will impact you over time.
All investments carry some level of risk including the potential loss of all money invested. This publication is not intended as legal or tax advice. Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation.