How Do I Pay Tax on a Roth IRA Conversion?

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Q. I’ve read that unless you have the cash on hand to pay the taxes on the Roth IRA conversion, it doesn’t make sense to convert. Is this true and are there any circumstances under which it might be wise or acceptable to pay the IRA taxes on your own?

– Investor

A. Let’s take a closer look at converting a Traditional IRA to a Roth IRA.

When you convert, you are voluntarily paying income taxes on your IRA now, so it will grow tax-free in the future.

People who convert a traditional IRA to a Roth do so because they think they are in a lower tax bracket now than they will be when they retire, said planner Bernie Kiely chartered financier and chartered accountant at Kiely Capital Management in Morristown.

Indeed, most people are in a higher tax bracket when they work than when they are retired, he said.

“Conventional wisdom says that the most efficient way to convert a traditional IRA to a Roth IRA is to pay the required income tax from a taxable account and not from the IRA itself,” said Kiely. “The reasoning is that you want to have the largest tax-free amount in your Roth IRA.”

He gave this example:

Suppose you are married and have $ 100,000 in taxable income for 2021. This puts you at the bottom of the 22% tax bracket. You have $ 500,000 in an IRA and you want to convert $ 100,000 of it to Roth. Additional federal income taxes on your Roth conversion of $ 100,000 will be $ 22,545. Part of your conversion will be taxed in the 22% and 24% tax brackets.

“If you have enough funds in a taxable bank account to pay taxes, you will have $ 100,000 in your Roth account which will grow tax free,” he said. “If you can’t cover the tax then you’ll have to withhold $ 22,545 from the IRA and only $ 77,455 will end up in your Roth.

One circumstance that would justify paying IRA taxes would be if you are very young and plan to receive a huge windfall such as a large inheritance, and you are going to jump into the much higher tax brackets for the rest of your life, he said.

Email your questions to [email protected].

Karin Price Mueller writes on Bamboo column for NJ Advance Media and is the founder of NJMoneyHelp.com. Follow NJMoneyHelp on Twitter @NJMoneyHelp. Find NJMoneyHelp on Facebook. Register for NJMoneyHelp.com‘s weekly electronic newsletter.



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