Fiscal year 2010 will go down in history as the year in which a great many changes occurred regarding Roth conversions. For many investors, these new rules and regulations made it very advantageous to convert old traditional IRAs into Roth IRAs. However, conversions to Roth IRAs are considered to be taxable events, meaning that you will be subject to IRA taxes. If you’re considering this type of transfer, you’re likely wondering how much IRA tax you’ll owe on a Roth conversion.
If any of your contributions to a traditional IRA were before tax – and chances are good that they were – you’re going to owe IRA rollover tax on the full amount that you rollover to a Roth IRA. A good place to begin when calculating how much you’ll owe is to determine how much of the distribution is considered to be nontaxable. When you convert your traditional IRAs to a Roth IRA, the nontaxable part is the total amount of the nondeductible contributions you made to the IRAs, less the total of any nontaxable distributions you received in the past.
In general, the amount of IRA rollover tax you pay on the Roth conversion will depend mainly on your tax bracket. Keep in mind, though, that your tax bracket can change if your taxable income increases. If you find yourself at or near the end of a particular tax bracket before you make the conversion, be very careful about adding any additional income to your tax return. There’s a distinct possibility that the rollover funds may push you into the next higher tax bracket and the IRS will take a bigger bite out of all your income for that fiscal year.
For this reason, it’s important to check with a tax professional or the manager of your Roth account about the specifics of your situation. You may find it more advantageous to make several limited rollovers over the course of several years, instead of performing one single rollover. On the other hand, the tax burden may be more than offset by other advantages of having a Roth IRA. This is where the advice of a trained financial professional is invaluable.
Regardless of how much actual tax burden you’ll have in fiscal 2010, the simple fact that you’re doing a Roth conversion in this tax year allows you to spread the IRA tax payment out over tax years 2011 and 2012, minimizing the amount you’ll pay at once. While the exact amount of the tax burden depends on factors including the total value of the money converted and your tax bracket, spreading out the tax burden is an option you should definitely take advantage of, as it will allow you to minimize the shock of the conversion, while still reaping all the benefits that a Roth IRA affords.
By changing the rules, the IRS’s goal was that many investors would consolidate their investments and even increase the amount of savings that they put away for retirement. There are many good reasons to include a Roth IRA in your retirement savings plan. Speak with your financial advisor about the role they could play in your retirement portfolio as part of your comprehensive savings strategy.