By Kevin Luu, Co-Founder and Chief Learning Officer. Reviewed on 2026-09-30.
No. Capital gains inside a Roth IRA are not taxed when they happen, and they are never taxed at all if you take them out as a qualified distribution: generally after age 59½ and at least five years after your first Roth IRA contribution or conversion. You can sell, rebalance and collect dividends inside the account with no tax return entry for any of it.
The gains only become taxable if you withdraw earnings early. Then they are taxed as ordinary income, not at capital gains rates, and usually with a 10% federal penalty on top. For a California family earning $950,000, that difference is worth more than it looks, because California taxes every capital gain as ordinary income anyway.
How gains inside a Roth IRA are treated, year by year
A Roth IRA is a tax wrapper, not an investment. Whatever you hold inside it (index funds, ETFs, individual stocks) follows these rules, set out in IRS Publication 590-B:
- While the money stays in: no tax on realized gains, dividends or interest. Short-term and long-term gains are treated the same, because neither is taxed.
- Qualified withdrawal: fully tax-free, contributions and growth alike. Qualified generally means you are 59½ or older (or disabled, or it is paid to a beneficiary after death, or up to $10,000 for a first home) and the five-year period has passed.
- Non-qualified withdrawal: money comes out in a fixed order. Your regular contributions come first and are always tax- and penalty-free. Converted amounts come next. Earnings come out last, and only that last layer is taxable as ordinary income, typically with the 10% additional tax if you are under 59½.
- Losses: a loss inside a Roth IRA cannot be deducted. There is no tax-loss harvesting inside the account.
Roth IRAs also have no required minimum distributions for the original owner (IRS RMD FAQs), so the gains can keep compounding untaxed for as long as you live.
Are capital gains taxed in a traditional IRA?
Not while they sit there, but they are taxed later, and at a worse rate. Every dollar you withdraw from a pre-tax traditional IRA or 401(k) is taxed as ordinary income. A gain that would have qualified for the 20% federal long-term rate in a brokerage account is taxed at up to 37% when it leaves a traditional IRA. Among retirement accounts, the Roth is the one where growth can escape tax completely.
What the tax-free growth is worth at a $950,000 household income
Take a married couple in San Jose filing jointly: one spouse at a biotech company, one a physician, $950,000 of combined W-2 income for 2026, two children aged 4 and 8. Assume their taxable income lands around $900,000. Here is what a $100,000 gain costs in a taxable brokerage account compared with inside a Roth.
| Where the $100,000 gain is realized | Federal | NIIT | State | Total tax |
|---|---|---|---|---|
| Brokerage, long-term gain, California | 20% | 3.8% | 11.3% | $35,100 |
| Brokerage, short-term gain, California | 37% | 3.8% | 11.3% | $52,100 |
| Brokerage, long-term gain, Washington | 20% | 3.8% | 0% to 7% | $23,800 to $30,800 |
| Inside a Roth IRA, qualified withdrawal | 0% | 0% | 0% | $0 |
How the rates are set, for 2026 unless noted:
- Federal: the 20% long-term rate applies to married couples with taxable income above $613,700, and the 37% ordinary rate above $768,700 (Rev. Proc. 2025-32).
- The 3.8% Net Investment Income Tax applies to investment income once joint MAGI exceeds $250,000. It does not apply to qualified Roth distributions.
- California: there is no lower rate for capital gains. At this income the gain falls in the 11.3% bracket ($891,542 to $1,485,906 for joint filers in 2025, the latest schedule the FTB has published). California follows the federal treatment of Roth IRAs (FTB Publication 1005), so qualified withdrawals are free of California tax too.
- Washington: there is no wage income tax in 2026, but a 7% capital gains tax applies to long-term gains above the annual standard deduction ($278,000 for 2025, the latest published). Whether the 7% hits depends on the family’s other gains that year, such as a large RSU sale. Gains in retirement accounts are exempt. Washington has also enacted a 9.9% income tax on AGI over $1,000,000 starting in 2028 (WA DOR), which makes tax-free Roth growth more valuable for Seattle-area families over the long run.
The same idea over 15 years
Say both spouses fund a backdoor Roth IRA every year at the 2026 limit of $7,500 each, so $15,000 a year (holding the limit flat for simplicity). Assuming a 7% annual return (an illustration, not a forecast), after 15 years the accounts hold about $376,900: $225,000 of contributions and about $151,900 of growth. Taken out as qualified distributions, none of that growth is taxed. Had the same growth been realized as long-term gains in a California brokerage account at the 35.1% combined rate above, the bill would be about $53,300, before counting tax on dividends along the way.
How a high-income family gets money into a Roth at all
At $950,000 this couple cannot contribute to a Roth IRA directly. For 2026 the ability to contribute phases out for joint filers with MAGI between $242,000 and $252,000 (IRS Notice 2025-67). There are three common routes in:
- Backdoor Roth IRA. Make a nondeductible contribution to a traditional IRA ($7,500 per spouse for 2026), then convert it to a Roth IRA. There is no income limit on conversions. Each conversion is reported on Form 8606.
- Roth 401(k) deferrals. If the employer plan offers a Roth option, the $24,500 deferral limit for 2026 can go in as Roth. Gains in a designated Roth account get the same tax-free treatment on a qualified distribution (IRS Roth account FAQs).
- Mega backdoor Roth. Some plans, including those at several large tech and biotech employers, accept after-tax contributions and allow in-plan conversion. Total additions to a 401(k) are capped at $72,000 for 2026, so the room is $72,000 minus your deferrals minus the employer match. For someone deferring $24,500 with a $12,000 match, that is $35,500 more per year of potential Roth money.
Our page on withdrawing nondeductible IRA contributions covers the basis tracking that makes a backdoor work.
Common mistakes that turn a tax-free gain into a taxable one
- Forgetting old pre-tax IRAs. If either spouse holds a rollover IRA from a previous job, the pro-rata rule on Form 8606 makes most of a backdoor conversion taxable. Rolling that pre-tax balance into a current 401(k) before year end, if the plan accepts it, usually fixes this.
- Withdrawing earnings early. Earnings only come out after every contribution and conversion has already been withdrawn. If the parent in our example is 44 and has reached that earnings layer, a $10,000 withdrawal it is taxed at 37% federal plus 11.3% California, plus the 10% federal penalty and California’s 2.5% early distribution tax (FTB Form 3805P). That is about $6,080 on $10,000. Withdrawals that stay within your contributions cost nothing.
- Ignoring the conversion clock. Each conversion has its own five-year period for the 10% penalty if you are under 59½. For a clean backdoor where nothing was taxed at conversion, it rarely matters. It does matter if you converted pre-tax money.
- Triggering a wash sale across accounts. Selling a fund at a loss in your brokerage account and buying the same fund in your Roth IRA within 30 days before or after the sale disallows the loss, and the IRS has ruled you do not get the basis back later (Rev. Rul. 2008-5). Check dividend reinvestment and automatic purchases in the Roth before harvesting losses.
- Holding the wrong assets in the Roth. Because growth in a Roth is never taxed, it is usually the place for the holdings you expect to grow most, while bonds and cash can sit in pre-tax accounts.
The decision this family actually has to make
The question is rarely whether Roth growth is tax-free. It is how much new money goes in each year (backdoor, Roth 401(k), mega backdoor), which assets sit inside, and which account the family spends last. Many families at this income treat the Roth as the last account they touch, because it is the one where every extra year of growth stays out of tax entirely. Our retirement and employee benefits work covers plan features like after-tax contributions, and tax management covers how this fits with RSU sales and brokerage gains.
What to write down for your kids
A Roth IRA is often the account children inherit with the least tax attached. Under current rules most non-spouse beneficiaries must empty an inherited IRA within 10 years. A minor child of the owner can take smaller yearly distributions until reaching the age of majority, and then the 10-year period starts. Qualified Roth money typically comes out tax-free (Pub 590-B). That only helps if someone knows the account exists and why it was built.
- Which accounts are Roth, where they are held, and who is named as beneficiary.
- The annual backdoor steps you follow, so a spouse can repeat them.
- Why you left the Roth untouched while spending from other accounts.
As Kevin puts it: “Your kids don’t need to inherit your portfolio. They need to inherit your decision-making process.” A one-page note in your FamilyKnowledge® Library is enough. Our Age Five Wealth Education page explains how families turn decisions like this into lessons as children grow.
Frequently asked questions
Do I report Roth IRA capital gains on my tax return?
No. Sales, dividends and gains inside a Roth IRA do not appear on your return while the money stays in the account, and the custodian does not issue a 1099-B for them. You only report Roth activity when you take a distribution (Form 1099-R) or make a conversion (Form 8606). A qualified distribution is reported but not taxed.
Does the five-year rule start over with each backdoor conversion?
For qualified distributions, there is one five-year clock that starts January 1 of the first tax year for which you made a Roth IRA contribution or conversion. Separately, each conversion has its own five-year period for the 10% penalty if you are under 59½. For a backdoor conversion with no taxable amount, that second clock usually has no practical effect.
Can my child have a Roth IRA?
Yes, but only up to the child’s own earned income for the year, capped at $7,500 for 2026. Allowance, gifts and investment income do not count (Pub 590-A). For children under 12 this usually requires genuine paid work, such as acting or modeling income. Money given outright to children more often goes into a 529 or UTMA account.
Next step
List every IRA both spouses hold, pre-tax and Roth, with balances as of today. If any pre-tax IRA shows up, sort out the pro-rata issue before your next backdoor contribution. If you would like a second set of eyes on how your Roth, 401(k) and brokerage accounts fit together, the Tax & Wealth Assessment is a good place to start. This is general education, and the right move depends on your family’s full picture.
Kevin has advised high-income W-2 tech and biotech families since 2015, and leads the education-first Age Five Family Office from Brea, California.
Connect on LinkedIn → · About KevinThis is part of how we approach Tax Management for high-income W-2 families at Bright Advisers.
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