Series 7 Exam Question 302: Answer and Explanation

Question: 302

Which two of the following are true of Roth IRAs?

I. Contributions are made from after-tax dollars.

II. Contributions are made from pre-tax dollars.

III. Distributions are tax-free.

IV. Distributions are taxed on the amount above the amount of the contribution.

• A. I and III
• B. I and IV
• C. II and III
• D. II and IV

Correct Answer: A

Explanation:

A. The main difference between traditional IRAs and Roth IRAs is the tax implications. Contributions to traditional IRAs are made from pretax dollars (you can write them off on your taxes), whereas contributions to Roth IRAs are made from after-tax dollars (you can't write them off on your taxes). However, distributions (withdrawals) from traditional IRAs are taxed on the amount above contribution, whereas withdrawals from Roth IRAs are tax-free. When withdrawing from a Roth IRA, neither the amount invested, which was already taxed, nor the amount the account has gone up in value (appreciation) is taxed, which is a great benefit to Roth IRA holders.