Does Converting an IRA to a Roth Put You in a Higher Tax Bracket?
Original post by Mark Kennan of Demand Media
Converting from a traditional IRA to a Roth IRA allows you to pay taxes at your current rate to avoid paying income taxes on the distributions from the account. Roth IRA conversions make sense particularly when you find yourself in a lower income tax bracket than you expect to be in at retirement. However, depending on your other income and your conversion amount, your conversion may put you in a higher tax bracket.
Figuring Your Income Tax Brackets with a Roth IRA Conversion
Your tax bracket refers to the tax rate you pay on your last dollar of income. Each year, the IRS publishes the new income tax bracket for each filing status in IRS Publication 17. When you convert money in a traditional IRA to a Roth IRA, the amount of the conversion adds to your taxable income. If you are close to the next income tax bracket before accounting for the taxable income from the Roth conversion, or if you are converting a large amount, it may push you into a higher income tax bracket.
Higher Tax Bracket Concerns
If your Roth IRA conversion does boost you into a higher income tax bracket, consider whether the current year is the best time for you to make the conversion. The main advantage to a Roth IRA conversion is that you expect to pay a higher income tax rate at retirement than the current year. However, if you end up in a higher income tax bracket, that may no longer be true. Also, if you expect to fall in a lower income tax bracket in a later year, consider saving some or all of your conversion until then so you can pay a lower tax rate on the conversion.
Effects of Moving to a Higher Tax Bracket
When an IRA conversion bumps you into a higher income tax bracket, it does not mean that all of your income is taxed at that higher rate. Instead, the higher income tax bracket only applies to the amount of the Roth IRA conversion that falls in that tax bracket. For example, say you have $50,000 in income, the 24 percent tax bracket goes up to $56,000, the next tax bracket is 30 percent and you convert $10,000. The first $6,000 of the conversion is taxed at 24 percent and the last $4,000 is taxed at 30 percent because it falls in the higher tax bracket.
Paying the Conversion Tax
Especially when converting a larger amount from a tax-deferred IRA to a Roth IRA, you need to budget for how you will pay the income taxes on the conversion, even if you are not put into a higher tax bracket. For example, if your entire $11,200 conversion keeps you in the 25 percent tax bracket, you would still owe an extra $2,800 in income taxes. Rather than paying the taxes with a distribution from your conversion and losing an extra 10 percent to the early withdrawal penalty, try to save money from other sources or have your employer withhold extra from your income taxes.
- IRS.gov: Publication 590
- IRS.gov: Publication 17
- Fairmark; Sources of Funds for Conversion Tax; Kaye A. Thomas; September 2006
About the Author
Mark Kennan is a freelance writer specializing in finance-related articles. He has worked as a sports editor for "Ring-Tum Phi" and published articles on a number of online outlets. Kennan holds a Bachelor of Arts in history and politics from Washington and Lee University.