Which of the following is true about funds in a Roth IRA?

In a Roth IRA, the correct understanding involves the treatment of contributions made to the account. Money contributed to a Roth IRA is indeed taxed at the time of contribution. This means that individuals use after-tax income to make contributions, which is a central feature of the Roth IRA.

The significance of this taxation at the contribution stage is that when funds are eventually withdrawn, both the principal (the contributions) and the earnings can be taken out tax-free, provided certain conditions are met, such as being at least 59½ years old and having the account open for at least five years. Thus, although contributions themselves are taxed, the withdrawals in retirement do not incur additional taxes, making Roth IRAs particularly appealing for many investors.

Understanding that contributions are made with already taxed money (which pertains to the chosen answer) highlights the fundamental premise of how a Roth IRA functions compared to traditional retirement accounts, where contributions are often made pre-tax, resulting in taxable withdrawals.