Answers to Roth IRA Questions

Why wouldn’t you want tax-free growth potential and tax-free withdrawals in retirement? That’s what a Roth IRA can offer.

Everyone can’t contribute to a Roth IRA because there’s an income limit. It’s still possible to have a Roth IRA by converting money in a traditional IRA or another retirement savings account.

Here are some frequently asked questions about Roth conversions.

Does time of year matter?

Converting earlier in the year will probably give you more time to pay taxes. Taxes are due April 15 of the following year, so you may have more than 15 months to pay the taxes 

Due to the impact of COVID-19, the new date for filing federal income tax returns and making contributions to your IRA for 2019 is July 15, 2020. It is now unclear if state filings and payments are affected.

But there are also some advantages to converting later in the year:

  • You’ll have more information about your income. Since the amount you convert is considered taxable income, you would want to consider converting only the amount that would bring you to the top of your tax bracket.
  • You can start the 5-year rule. This IRS rule requires a waiting period of 5 years before withdrawing converted balances or you’ll have to pay a 10% penalty. The clock starts on January 1 of the year you do the conversion.

A conversion has to be completed by December 31st to be included in that year’s taxable income. 

How do I manage taxes on a Roth conversion?

A popular way to manage taxes on a Roth IRA conversion is to spread out the conversion over a few years. This spreads the taxes, and it may also prevent the income from the conversion from bumping you into a higher tax bracket.

Tax deductions can help offset the tax cost of a Roth IRA conversion. For instance, you may be able to take a tax deduction for donations to qualified charities. In general, if you make charitable contributions, you can deduct up to 60% of your adjusted gross income. The deduction is usually limited to 30% of AGI for donations to some private foundations and some other organizations, as well as for contributions of non-cash assets. If your itemized deductions which include charitable contributions do not go over the standard deduction, then there wouldn’t be any tax benefit from the charitable contributions. Be sure to consult with your tax advisor to plan your charitable strategy.

Can I convert to a Roth IRA even if I earn too much to contribute?

If you or a spouse have high income levels and aren’t eligible to contribute to a Roth IRA, and you do not have a traditional IRA, you should consider opening a traditional IRA and making a nondeductible contribution, then converting it to a Roth IRA. This method is generally called a “back-door Roth contribution”.

How do I estimate my tax liability on an IRA conversion?

Your tax liability is based off of the taxable income generated by the conversion and your applicable tax rate.

To see how much of a conversion from a traditional IRA to a Roth IRA can be taxable, you’ll need to know the types of contributions that you’ve made to any of your traditional IRAs (not just the one that is being converted). These are the 2 types of contributions:

Nondeductible contributions – Contributions that don’t take a tax deduction. These contributions create what is sometimes called “basis” in your traditional IRA.

Deductible contributions – Contributions that are deducted from your taxable income for the tax year in which contributions were made.

Estimating the taxable income from a conversion is pretty straightforward if you’ve never made nondeductible contributions to any traditional IRA. If this is the case, whatever amount you convert will all be taxable income.

Earnings are always taxable when converted, whether they come from deductible or nondeductible contributions, so for purposes of figuring out taxes on a conversion, you can think of your balances falling into 2 categories: nondeductible contributions and everything else. You cannot just convert nondeductible contributions, leaving deductible contributions and earnings in the account, in order to avoid taxes. You must figure out the proportion of your traditional IRA balances that is composed of nondeductible contributions, then use that percentage to find out how much of your conversion will be taxable according to IRS rules. Inherited IRAs are excluded in this calculation.

You should keep state taxes in mind too. If your state has an income tax, the conversion will probably be treated as a taxable income by your state as well by the federal government.

Do I still have to take a required minimum distribution in the year I convert if I’m over 72?

Yes you do for both workplace plans and for traditional IRAS. Typically, the first money withdrawn from your account each year has to satisfy your RMD and isn’t eligible for a rollover or conversion. Additional withdrawal amounts can be converted to a Roth IRA, which doesn’t require RMDs. While the Roth conversion does not count toward your RMD, you can use the after-tax value of your RMD funds to pay for at least part of a Roth Conversion.