How much will you owe?

Roth conversions are treated as ordinary income, and taxpayers must include the balance on their tax returns. How much you have to pay in taxes depends on the amount of the conversion plus your adjusted gross income. Here’s what you need to know. A financial advisor can help you put together a tax plan for your investments and retirement goals.

What is a Roth IRA?

A Roth IRA is a retirement account that is funded with after-tax money, meaning you’ve already paid taxes on it. So when you make a withdrawal, you don’t have to pay taxes on that money as long as you follow the rules.

A Roth IRA must be vested before you can make withdrawals. You must wait five tax years after your first IRA contribution to withdraw money. Your contributions are assumed to have occurred on January 1 of the tax year in which you begin making contributions. You cannot make withdrawals until after December 31 of the tax year that marks the fifth year of contributions. However, you do not need to take the required minimum distributions. You can grow money in a Roth IRA tax-free, with a few exceptions.

If you open a traditional IRA instead, you fund it with pre-tax dollars and it serves as a tax write-off in the year you make contributions. When you retire and start taking withdrawals, you pay income tax on the withdrawals and are subject to required minimum distributions.

If you’re ready to be paired with local advisors who can help you reach your financial goals, start now.

What is a Roth IRA conversion and how is it taxed?

A Roth IRA conversion occurs when you convert your traditional IRA to a Roth IRA or when you convert a portion of your 401(k) to a Roth IRA located in your retirement plan.

You are taxed on any amount of money you convert each tax year at your ordinary tax rate, not at the lower, preferred capital gains rate. The tax bill you’ll face could be significant and should be paid with non-retirement account funds to take full advantage of the conversion.

Unless you’re 59 1/2 or older, you’ll also have to pay a 10% early withdrawal penalty.

Roth Conversion Taxation

If you convert a traditional IRA to a Roth IRA or do an in-plan Roth conversion, you must pay taxes on the amount of deductible, pre-tax income you convert. Traditional IRAs are funded with pre-tax income. If you convert to a Roth plan, you may also convert some pre-tax funds. A good rule of thumb to follow is that you must pay income taxes on any pre-tax funds you convert to a Roth IRA. Your tax rate is the marginal tax rate on the amount of your income, including the conversion amount.

The story continues

If there are nondeductible funds in your traditional IRA or 401(k), they may have a tax-free portion. You will calculate the nontaxable portion on IRS Form 8606.

Let’s say you decide to convert $50,000 from your traditional IRA to a Roth IRA, and the entire amount was deductible. If you’re in the 22% tax bracket, that means you’ll pay $11,000 (0.22 x $50,000) in taxes when you convert the $50,000 to a Roth IRA. If the $50,000 pushes you into a higher tax bracket when added to your adjusted gross income at the end of the year, then you calculate your tax liability using the marginal tax rate for your higher tax bracket.

If you’re scheduled to take a required minimum distribution (RMD) on the retirement account you’re converting from, you must take that RMD before you convert or you’ll face penalties.

Paying Taxes on a Roth Conversion

You will have the opportunity to pay taxes on the proceeds of your Roth conversion at the time of conversion. It is best to have a tax accountant or financial advisor provide advice and assistance if you are considering a Roth conversion. You may have to pay conversion taxes either at the time of conversion or as estimated tax payments during the tax year of the conversion. It is not wise to wait until the tax deadline for the year to pay your taxes, as you may incur penalties. A tax accountant or financial advisor can best guide you.

Conclusion

A Roth conversion can benefit you in retirement, when you’ll have more after-tax income available. To take full advantage of your after-tax retirement income growth, you need to follow the rules. A tax accountant or financial advisor can guide you through these.

Tools for Retirement Planning

• A financial advisor can help you optimize your retirement investments to minimize your tax liability. Finding a qualified financial advisor doesn’t have to be difficult. The free SmartAsset tool matches you with up to three financial advisors serving your area, and you can interview advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your goals financial, start now.

• How much your 401(k) will be worth in retirement. Use the SmartAsset 401(k) calculator to find out.

• SmartAsset has a retirement calculator that will help you determine how much you will need in retirement. Check.

• Keep an emergency fund handy in case you face unexpected expenses. An emergency fund should be liquid — in an account that isn’t exposed to significant fluctuations, such as the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But a high interest account allows you to earn compound interest. Compare savings accounts from these banks.

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