Tax Facts

3652 / How are earnings on an IRA taxed?

An IRA offers tax-free build up on contributions. The earnings on a traditional IRA are tax deferred to the owner; that is, they are not taxed until the owner begins receiving distributions ( Q 3671). The earnings on a Roth IRA may or may not be taxed upon distribution ( Q 3673). Like a trust that is part of a qualified plan, an individual retirement account is subject to taxes for its unrelated business income ( Q 3974, Q 4098).

Tax deferral is lost if an individual engages in a prohibited transaction ( Q 3980) or borrows under an individual retirement annuity. The loss occurs as of the first day of the tax year in which the prohibited transaction or borrowing occurred.1 For an account established by an employer or association of employees, only the separate account of the individual loses its deferred status.

Planning Point: Prohibited transactions include: borrowing money from the IRA, selling property to it and using IRA assets for personal use or as security for a personal loan. Additionally an IRA is prohibited from investing in collectibles (e.g. artwork, antiques, stamps) and life insurance.

1.   IRC § 408(e); Treas. Reg. § 1.408-1.

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