Tax Consequences for a Traditional IRA to Roth Rollover
Original post by Emily Weller of Demand Media
When you convert or roll over a traditional IRA to a Roth IRA, you no longer have to worry about paying taxes on any distributions you take after retirement. Instead, you will have to pay taxes on the amount you've rolled over, as long as you previously deducted the amount from your income tax.
If you've deducted the amount you contributed to a traditional IRA from your income in the past, you will owe income tax on that amount that you roll over. You will also owe tax on any earnings from the traditional IRA. You can't claim the earnings as capital gains on your tax return. Usually, income tax is due on the amount you've rolled over in the year of the conversion. For 2010, you were able to split the taxes due between the years 2011 and 2012.
The addition of income from converting a traditional IRA to a Roth may push you into a higher tax bracket for the year, which will raise the amount of tax you'll owe. For example, if you are in the 15-percent bracket, converting $10,000 can push you into the 25-percent bracket, which may make the conversion not worth it financially, as you may wind up paying more to convert than if you had left the money in a traditional IRA.
Deductible and Nondeductible Amounts
Not all money invested in a traditional IRA is deductible from income tax. If you were only able to deduct a portion of your contributions and paid tax on the remaining amount, you cannot only roll over the nondeductible amount and avoid paying any taxes. For example, if you contributed $25,000 to a traditional IRA and only deducted $12,500 of that from your taxes, you will have to treat half of your rollover as taxable income and the other half as already taxed, even if you roll over less than $12,500. If you roll over $3,000, $1,500 is taxable.
Avoiding the Additional Penalty
When you convert from a traditional to a Roth IRA, you avoid the 10-percent penalty that applies to most early withdrawals, since you are not withdrawing the money. If you find that you do not have enough money to pay the additional income tax, though, and decide to use a portion of the converted amount to pay the additional tax, you will then have to pay the penalty as well. Do a rollover only if you can pay the tax using money that doesn't come from the IRA itself.
- IRS.gov; Retirement Plan FAQs Regarding IRAS; 2011
- SmartMoney; IRA to Roth IRA Conversion Calculator; 2011
- Bankrate; Take Tax Control of Your IRA Conversion; Kay Bell; 2008
About the Author
Based in Pennsylvania, Emily Weller has been writing professionally since 2007, when she started writing theater reviews for offoffonline.com and Theater Talk's New Theatre Corps Blog. Her writing covers a wide range of topics including theater, vegetarianism, travel and news. Weller has a Master of Fine Arts in dramaturgy and theater criticism from CUNY/Brooklyn College.
- Comstock/Comstock/Getty Images