How a Roth IRA Works and Provides Tax-Free Income

03.16.2026 | Category: Financial Planning

Reviewed by: Mark Zagurski, CLU®, ChFC®, CMFC® and CRPC®

Summary: A Roth IRA can help you build retirement savings with tax-free growth and tax-free qualified withdrawals. Understanding how it works, and when it makes sense, can help you create more flexibility and predictability in retirement.

Key takeaways

A Roth IRA is funded with after-tax dollars
Investments grow tax deferred
Qualified withdrawals in retirement are generally tax free
Income limits apply to contributions
Roth IRAs can support long-term retirement income planning

What is a Roth IRA?

A Roth IRA is an individual retirement account that allows your investments to grow tax deferred, provided IRS rules are met. Contributions are made with after-tax dollars, meaning you don’t receive a current tax deduction. In exchange, qualified withdrawals in retirement are generally federal income tax free.

A Roth IRA is also one of the most widely used retirement savings tools. In fact, a Mutual of Omaha survey reports, 38% of adults age 40+ report owning a Roth IRA. For many households, it offers more than just a way to save; it creates flexibility around future taxes, retirement income, and even legacy

How does a Roth IRA work?

A Roth IRA works by reversing the traditional retirement tax timing. Instead of receiving a tax benefit upfront, you pay taxes on contributions while you’re working.

Once contributions are made, investments inside the account grow without being taxed year to year. When you withdraw money in retirement (assuming you meet age and holding requirements), qualified distributions are generally tax free.

For many people, that tradeoff is appealing. 44% of adults age 40+ say they prefer paying taxes now in exchange for tax-free income later*. This approach can be especially helpful for those who expect to be in a higher tax bracket in retirement or who want greater predictability around future income taxes.

As Mutual of Omaha Advisors’ Director of Strategy & Communications and host of the Make it Personal Podcast, Mark Zagurski explains, “We don’t know where taxes will be in the future, but many experts suggest that with current deficits, tax rates may have nowhere to go but up.” For some savers, that uncertainty makes locking in today’s tax rate feel like a form of protection.

Who can open and contribute to a Roth IRA?

To contribute to a Roth IRA, you must have earned income. You can contribute at any age if you meet IRS income limits based on your Modified Adjusted Gross Income (MAGI). MAGI is calculated as part of your tax return and may include adjustments beyond your base salary.

For 2026:

Single filers can make a full contribution if their MAGI is below $153,000, with contributions phasing out between the $153,000 and $168,000.
Married couples filing jointly can make a full contribution if their MAGI is below $242,000, with contributions phasing out between $242,000 and $252,000.

Because income can fluctuate — especially with bonuses, commissions, or business income — eligibility should be reviewed each year. As Zagurski cautions, “The danger of a ‘set it and forget it’ mentality is that you might hit the high end of income limits, leading to excess contributions and avoidable tax stress.”

Roth IRA contribution limits

For 2026, the maximum contribution is:

$7,500 if under age 50
$8,600 if age 50 or older

These limits apply across all IRA accounts combined and must be made by the tax filing deadline for the year.

Roth IRA withdrawal rules

One of the most distinctive features of a Roth IRA is its withdrawal flexibility. Zagurski notes “you can generally withdraw your after-tax contributions at any time without paying taxes on them.”

Withdrawing earnings follows different rules:

Under the five-year rule, earnings can generally be withdrawn tax and penalty free if you are at least age 59½ and the account has been open for at least five tax years.
Early withdrawal of earnings may trigger taxes and penalties

The five-year rule is important. As Mutual of Omaha Financial Advisor and Certified Financial Planner (CFP®) Adam Olson explains, “The 5-year rule is a vital piece of flexibility”.

That flexibility matters to savers. In fact, 32% of adults age 40+ say the ability to withdraw contributions at any time is one of the most important Roth IRA benefits.* It can provide valuable options during life transitions, whether adjusting to early retirement, helping fund education expenses, or navigating unexpected financial needs.

Can a Roth IRA grow and can it lose value?

A Roth IRA can grow through the investments held inside the account, such as stocks, bonds, mutual funds, and exchange-traded funds. Growth depends on market performance and investment choices, and returns are not guaranteed.

Like any investment account, a Roth IRA can also lose value if investments decline. While the tax-deferred treatment does not protect against market risk, it can help preserve more of your gains over time if investments perform well.

Benefits of a Roth IRA

A Roth IRA offers several potential benefits:

Tax-deferred growth
Tax-free qualified withdrawals
No required minimum distributions (RMDs) during your lifetime
Flexibility in retirement income planning
Potential legacy advantages

Zagurski adds, “A significant benefit of Roth IRAs is the lack of Required Minimum Distributions (RMDs), meaning the government doesn’t force you to withdraw money at an arbitrary age.”

That absence of RMDs allows assets to potentially continue compounding longer and may make Roth IRAs especially attractive in legacy planning.

As, CFP® Olson explains, “If you are legacy-focused, a Roth IRA is a powerful tool because your kids or grandkids can inherit that income generally tax-free.”

Potential disadvantages to consider

A Roth IRA may not be the right fit for everyone. Considerations include:

No immediate tax deduction: you cannot subtract your Roth IRA contributions from your taxable income in the year you contribute, which may reduce the short-term tax benefit compared to some other retirement accounts.
Income limits restrict eligibility: higher earners may not be able to contribute directly, depending on IRS income thresholds.
Contributions are made with after-tax dollars: you pay income taxes on the money before investing it, rather than deferring taxes until retirement.

Weighing these trade-offs alongside your income, tax situation, and long-term goals is an important part of retirement planning.

Using a Roth IRA in retirement

In retirement, a Roth IRA can provide tax-free income that does not increase taxable income. That may help:

Supplement Social Security income
Reduce taxable income in certain years
Provide flexibility when managing withdrawals

Olson, CFP® explains, “A Roth IRA allows you to take out large lump sums for major goals, like a once-in-a-lifetime family trip, without spiking your income taxes or your future Medicare premiums.”

This flexibility can be especially valuable as health needs, income sources, and tax considerations change as you age.

Considering your options

Retirement decisions are deeply personal. Our research shows that household income (49%) and time until retirement (55%) are the most significant factors in choosing retirement accounts.* That’s why understanding how Roth IRAs compare to other accounts can help you build a strategy that fits your specific situation.

How is a Roth IRA different from a Traditional IRA?

The main difference is when taxes are paid. Roth IRAs are funded with after-tax dollars and offer tax-free qualified withdrawals in retirement. Traditional IRAs may provide a tax benefit upfront, but withdrawals are generally taxed later.

How does a Roth IRA compare to a 401(k)?

A 401(k) is offered through an employer and may include matching contributions. A Roth IRA is opened individually and can offer greater flexibility around investments and future tax treatment. Some people also convert 401(k) funds to a Roth IRA, though taxes typically apply at the time of conversion. Learn more about IRAs and 401(k)s.

Zagurski emphasizes, “A balanced retirement strategy often involves splitting 401(k) contributions between traditional and Roth accounts to create maximum flexibility for future income.”

Want help deciding if a Roth IRA is right for you?

Talk with a Mutual of Omaha financial professional to review your options.

Frequently asked questions about Roth IRAs

How do you set up a Roth IRA?

You can set up a Roth IRA through a financial institution, such as a bank, brokerage, or financial professional, by completing an account application and choosing investments. While it’s possible to choose investments on your own, working with a financial professional is often a smart choice. They can help you build a thoughtful strategy, avoid common mistakes and make sure your investments align with your long-term goals.

Can I start a Roth IRA for my child or grandchild?

Yes. You can open a Roth IRA for a child or grandchild as long as the child has earned income, such as wages from a job. Contributions cannot exceed the child’s earned income for the year and must follow IRS contribution limits.

Does a Roth IRA earn interest?

A Roth IRA doesn’t earn interest on its own. It’s an account that holds investments, and its growth depends on what you invest in. Some investments may earn interest, while others grow through market returns or can lose value.

What is the five-year rule for a Roth IRA?

The five-year rule requires your Roth IRA to be open for at least five tax years before earnings can be withdrawn tax free, in addition to meeting age or other qualifying requirements.

Should I open a Roth IRA?

That depends on your income, tax situation, and retirement goals. A Roth IRA may be helpful if you value tax-free income later in life.

Do you report a Roth IRA on taxes?

You generally don’t report Roth IRA growth or qualified withdrawals on your tax return because they’re typically tax free. However, contributions and conversions are reported on specific IRS forms, such as Form 8606.

Can you have more than one Roth IRA?

Yes. You can own multiple Roth IRAs, but your combined annual contributions across all accounts cannot exceed IRS limits.

Reviewed by: Mark Zagurski, CLU®, ChFC®, CMFC® and CRPC®

Mark is Mutual of Omaha Advisors’ Director of Strategy & Communications. With more than 30 years of experience, he has worked extensively in advisor development, strategy, and communications, focusing on helping advisors and their clients make informed financial decisions. He is also the host of the Mutual of Omaha Advisors podcast, “Make it Personal,” which explores personal finance and strategies to help you take control of your money and future.

Source:

*Based on Mutual of Omaha proprietary survey of U.S. adults age 40+ with household income of $50,000+, conducted February 6–9, 2026.

Disclosures:

Registered Representatives offer securities through Mutual of Omaha Investor Services, Inc., Member FINRA/SIPC. Investment Advisor Representatives offer advisory services through Mutual of Omaha Investor Services, Inc. Mutual of Omaha Advisors is a division of Mutual of Omaha Insurance Company.

All investing involves risk, including the possible loss of principal, and there can be no assurance that any investment strategy will be successful.

Mutual of Omaha and its representatives do not provide tax and/or legal advice, and the information provided herein is general in nature and should not be considered tax and/or legal advice.

Not all Mutual of Omaha agents are registered representatives or financial advisors.

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