How Much Tax Will I Owe on My Rollover IRA/Roth IRA Conversion?

22 Apr

Legal changes that have taken place in 2010 are making Roth IRA conversions and rollovers more attractive to investors than ever. If you’re one of these Rollover IRA/Roth IRA investors, you’ll need to carefully consider the tax implications of rolling over to or converting to a Roth IRA before making any rash decisions that could affect your financial future.

The main characteristic that sets Roth IRAs apart from other IRAs is that Roth IRAs are funded with income upon which you’ve already paid federal and state income tax.  Conversely, most IRAs are funded with income upon which you haven’t yet paid federal or state income tax.  This means that when you rollover to or convert to a Roth IRA, you will be expected to pay income tax on those funds.

The question of how much tax you’ll owe depends on a number of factors, including how much money is involved and what your current tax bracket is.  Bear in mind also that you aren’t required to convert the entire balance of your traditional IRA to a Roth IRA at once – you can convert as much or as little as you choose at a time.  If you have further questions about these requirements, check out the IRS website for more information or, better yet, speak with your personal financial adviser or tax accountant.  He or she can help you to determine exactly how much tax you’ll be required to pay.

Another legal change that takes place in the year 2010 is when the Roth IRA taxes you owe will be due.  If you roll over to or convert to a Roth IRA in 2010, you’ll pay half of the taxes due in 2011 and the remaining half in 2012.  This allows you to spread out the tax burden, which could be a real bonus if you’re considering rolling over or converting a significant amount of money.  Again, your personal financial adviser or tax accountant can help you determine not only exactly how much tax you’ll be required to pay, but also how that will affect your taxes for the years 2010, 2011 and 2012.

Another bit of good news – if you choose to rollover your IRA to a Roth IRA or convert your funds to a Roth IRA, you’ll probably avoid the mandatory withholding and/or penalties that you would have incurred had you chosen to just cash out your IRA.  If you do decide to cash out your IRA instead of performing a Roth IRA conversion, you’ll also lose out on the benefit of deferring the tax burden and spreading it out over two years.

As you can see, rolling your IRA over to a Roth account or converting your funds to a Roth IRA isn’t without its tax consequences.  However, those tax consequences are less of a burden now than they’ve been in years past, making it a perfect time to consider this change in your retirement savings strategy.  Paying the required taxes now, during your rollover or conversion, may also play an important role in your estate planning, as it will minimize the necessary taxes for those who receive any funds in the Roth IRA from your estate later in life.

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