Traditional-to-Roth IRA Conversion Tax Guide

How much tax will you pay to convert a traditional IRA to a Roth IRA?

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Roth IRAs are a popular way for people to save for retirement. They offer roughly the opposite tax benefits of traditional IRAs. Instead of letting you defer taxes until you make withdrawals, with a Roth IRA, you pay taxes as normal on amounts being contributed and can later withdraw money from the account tax-free during retirement.

Once you have a traditional IRA, you have the option to convert some or all of the account’s balance to a Roth IRA. This can have tax implications, so it’s important to choose the right time to make the conversion and to make sure it’s a suitable choice for you. Let’s walk through the process and examine how to decide whether a traditional-to-Roth conversion is a good idea.

Key Takeaways

  • You can convert traditional IRA balances to Roth IRA balances.
  • You will owe income tax on any amount converted in that year’s tax return.
  • Once in a Roth IRA, your money will grow tax-free.

How Does a Roth Conversion Work?

A Roth IRA conversion involves taking some or all of the money in a traditional IRA and converting it to a Roth IRA.

For example, if you have $10,000 in a traditional IRA, but would rather move it to a Roth IRA, you can convert it so that you have $10,000 in a Roth IRA instead. Typically, your brokerage can help you with this process, and it should be relatively easy.

If you’d like, you also can convert just a portion of your traditional IRA balance. For example, you could convert half of this traditional IRA balance to a Roth, leaving you with $5,000 in each account.

Keep in mind that if you convert your traditional IRA to a Roth IRA, the new account will be subject to all the rules that apply to Roth IRAs, such as the five-year minimum holding period before you can make withdrawals. On the other hand, it also means you can avoid required minimum distributions (RMDs).

Remember that you have to pay income tax on any amount converted, so you’ll need to have the funds to cover the tax bill.

When Would You Do a Roth Conversion?

If you have a traditional IRA, you can do a Roth IRA conversion at any time. However, it isn’t always the best idea. There are a few specific scenarios in which a Roth IRA conversion can be a good idea.

You Have Little Income This Year

When you withdraw money from a Roth IRA, you pay no taxes on the amount withdrawn. This is different from a traditional IRA, where you pay income taxes on withdrawals during retirement.

If you have little income in a year and are in a low tax bracket, or even have little-enough income not to pay income tax at all, you can take advantage of this. When you convert your IRA to a Roth IRA, you’ll pay income tax at your current tax rate. If your income tax rate in retirement is higher, converting now means paying less tax overall.

You Want To Use the Backdoor Roth IRA Strategy

Roth IRAs have restrictions on who can contribute. For example, you can’t put money in an IRA if your income is too high. You can get around this restriction by funding a traditional IRA first, then converting that IRA to a Roth IRA, in an option called a “backdoor IRA.”

You Want To Avoid Required Minimum Distributions

With traditional IRAs and other tax-deferred retirement accounts, you are required to withdraw some money from the account as you get older. Roth IRAs have no required distributions for as long as you live, giving you more control over how you manage your money.

How Much Tax Will You Pay on a Roth Conversion?

When you convert a traditional IRA to a Roth IRA, the amount you convert is treated as income. Because you did not pay income taxes when adding the money to the IRA, you have to pay them for the tax year in which you convert the balance to a Roth account.

You will be required to pay both federal and state income taxes on any amount you convert. The higher your income, the more you’ll have to pay in tax.

How To Calculate Your Taxes

To calculate the tax implications of a Roth IRA conversion, you need to know your taxable income, the amount you plan to convert, and the tax rates for both your state and federal income taxes.

Consider a single taxpayer who lives in Massachusetts, which has a state income tax of 5% for the 2021 tax year. The person has a taxable income of $50,000 after accounting for any deductions and tax benefits they’re eligible for.

In 2022, the federal tax brackets for single filers are:

Income Tax Rate
$0 - $10,275 10%
$10,276 - $41,775 12%
$41,776 - $89,075 22%
$89,076 - $170,050 24%
$170,051 - $215,950 32%
$215,951 - $539,900 35%
$539,001+ 37%

Keep in mind that tax rates are marginal. Someone with a taxable income of $11,000 pays 10% tax on the first $10,275 they make and 12% tax on only the $725 they make over that amount.

Based on taxable income of $50,000, the taxpayer in this example would pay:

($10,275 *0.1) + ($31,500 * 0.12) + ($8,225 * 0.22) = $6,617 in federal income tax

They also would pay:

$50,000 * 0.05 = $2,500 in Massachusetts state tax

$6,617 + $2,500 = $9,117 total tax

To determine the amount of tax on a Roth IRA conversion, you add the amount converted to the taxpayer’s income, then find out the additional tax they would owe.

For example, if the taxpayer chose to convert a $10,000 traditional IRA to a Roth IRA, their new taxable income would be $60,000, making their tax bill look like this:

($10,275 * 0.1) + ($31,500 * 0.12) + ($18,225 * 0.22) = $8,817 in federal income tax

$60,000 * 0.05 = $3,000 in Massachusetts state tax

$8,817 + $3,000 = $11,817 total tax

That means that the Roth IRA conversion incurs a tax bill of $2,700.

How To Pay Taxes on a Roth Conversion

When you convert your traditional IRA to a Roth IRA, you’ll owe taxes on the conversion. If you wait until you file your taxes to pay the bill, you might wind up owing penalties for underpayment. If you expect to owe taxes at the end of the year, the IRS expects you to make quarterly estimated tax payments to make up for the money you expect to owe.

It’s usually best to pay these taxes using money from outside your IRA. If you try to use some of the funds from your IRA to pay these taxes and you’re under age 59 1/2, you’ll be subject to the 10% early withdrawal penalty.  You’ll also wind up with less money in your Roth.

Another way you can pay the taxes that you owe from a Roth conversion is by requesting that your employer withhold additional taxes from your paycheck.

Raising your payroll withholding increases the amount you send to the government with each check and might be simpler than dealing with estimated tax payments. You can adjust your employer withholding by changing the Form W-4 that your employer has on file.

Is a Traditional-to-Roth IRA Conversion Worth It?

Converting from a traditional IRA to a Roth IRA can be useful in a few situations, such as when you’re getting around income restrictions or think you’ll be in a higher tax bracket during retirement. However, it’s important to consider your personal financial circumstances and to weigh the tax implications against the benefits to make sure it’s the right choice for you.

Frequently Asked Questions (FAQs)

When is the best time to start a traditional-to-Roth IRA conversion?

You can start a Roth IRA conversion at any time. In general, it makes sense to do a conversion when you have low income, which places you in a low tax bracket. It may be best to do it late in the year when you have a good idea of what your income will be so you can make sure the conversion and resulting tax bill are worth doing.

Can you avoid taxes on a Roth conversion?

There are ways to limit the tax you pay on a Roth IRA conversion, but it’s hard to avoid them entirely. If your income is very low, you might be able to reduce your taxable income to $0 with the standard deduction, letting you convert some balance without paying tax. To reduce the tax you pay, try to convert in years in which your income is low, and convert as much as you can while in a low tax bracket.

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