You Asked Us -Roth IRA Conversions

Q. An individual has about $250,000 in a traditional IRA, and wants to convert the amount to Roth IRA.

However, converting the entire balance will push her in a higher tax bracket, and she cannot afford to pay all the taxes that will be owed in one year.  She does not want to pay the taxes owed with her IRA funds, but instead prefers to pay it out of pocket (with non-IRA funds). Can she convert a little of it each year?

A. Her decision not to use her IRA assets to pay the taxes that would be owed on the conversion is a wise one, as paying the taxes with IRA assets would be a bad move for more reasons which include the following:

• It would reduce her IRA balance, leaving a lesser amount to accrue earnings on a tax-deferred basis

• She would lose the benefit of enjoying compound tax-deferred (or tax-free in the case of a Roth IRA) earnings on the amount withdrawn to pay taxes

• The amount withdrawn to pay taxes would be treated as a distribution, subject to ordinary income tax at her tax-rate.

On the matter of converting a small amount each year: that is definitely permissible, and is a strategy recommended by many tax-professionals. Partial conversions (converting less than the entire non-Roth IRA balance), allows the taxpayer to lessen the tax impact of the Roth conversion, and allows the owner to spread the taxes over more than one year. The taxpayer can choose to convert amounts only in years when the tax impact would be lower, and/or she can afford to pay the taxes due out of pocket.

Tip: Individuals who completed Roth conversions, and determine that they are unable to pay the taxes due on the converted amount can recharacterize the entire conversion or a percentage of the conversion. The amount that is recharacterized is treated as if it was never converted for tax purposes.

Featured Product/s

• RetirementWorks® II ("RW2")
• Appleby Cheat Sheets .