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Tax on a Converted IRA

Original post by Maggie McCormick of Demand Media

The benefit of a traditional IRA is that you don't have to pay taxes on the money now; you pay them when you withdraw the money. A Roth IRA, on the other hand, allows you to pay with taxed dollars and withdraw the money and earnings tax-free, provided you had the account at least 5 years. If you think that the Roth IRA might be a better option for you, you can convert your traditional IRA to a Roth -- you just have to pay Uncle Sam.

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Taxable Amount

When converting a traditional IRA to a Roth IRA, you must pay taxes on any transferred amount that was pre-tax dollars. In most cases, this is the full amount that you're converting, but there may be cases where you forgot to take a deduction and accidentally funded the traditional IRA with taxed dollars. You can choose to convert only a portion of the fund in your traditional IRA to a Roth.

How Much

The amount that you'll pay in taxes depends on your current income and tax rate, but the amount can be considerable, depending on your situation. A tax calculator can help you determine how much it will cost you to make the conversion.

Paying the Taxes

You reap the most benefits if you can afford to pay the taxes from your personal savings, but it's also possible to have that money withdrawn from the IRA assets in the conversion. Another alternative is to have more taxes withheld from your paycheck. Your human resources department will have a form that you can fill out to make the change.

Managing the Tax Bite

There is no limit to the number of Roth conversions you can make. It's possible to convert a small amount each year to minimize the yearly tax bill. Though the rules in 2010 offered a one-time chance to spread the tax bill of a conversion over two years, the opportunity for that has passed. There is no significant tax benefit to converting the entire traditional IRA to a Roth at one time.


                   

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About the Author

Maggie McCormick is a freelance writer. She lived in Japan for three years teaching preschool to young children and currently lives in Honolulu with her family. She received a B.A. in women's studies from Wellesley College.


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