What happens to Roth IRA contributions once they are made?

When contributions are made to a Roth IRA, they are taxed at the time of contribution. This is a fundamental characteristic of Roth IRAs, distinguishing them from traditional IRAs, where contributions may be tax-deductible depending on the taxpayer’s income and situation.

In a Roth IRA, individuals use after-tax dollars to contribute, meaning they pay income taxes on the money before it is contributed. As a result, qualified withdrawals from a Roth IRA in the future are generally tax-free, which can be highly advantageous, especially for younger savers who expect their income, and consequently their tax rate, to be higher in retirement when they begin making withdrawals.

Understanding this tax treatment is crucial for effective tax planning and retirement savings strategy, allowing individuals to maximize the tax benefits of their retirement accounts.