Tax Options for a Roth Conversion

by Susan Reynolds

A Roth IRA is a retirement account that allows you to sock away after-tax dollars for retirement, which then grow tax-free. You only pay income tax on Roth IRA money if you withdraw earnings before the age of 59 1/2. If you decide a Roth IRA is a better option than your traditional IRA, you can convert to one. To do so, however, you will have to pay income taxes on the money in your traditional IRA. You have three choices on how to pay your Roth conversion income taxes.

Pay Taxes with Last Year's Tax Return

You can elect to pay all of the conversion taxes in one year. One reason to convert taxes during the conversion year is if you expect to make more money in the next two years. You do not have to decide on a taxpaying option until next year's tax deadline, so you can determine if it is better to pay during the conversion year or spread out the payments.

Pay Over Three Years' Time

Another option is to pay the taxes over the course of three years. You would have to declare some of the conversion money as income on this year's taxes. In the next two years, you can declare the other portions of the conversion. One caveat to choosing this option is that you may have to increase your estimated tax payments each year, but you will have to consult a tax adviser.

Use Two-Year Tax Rule

The default way to pay taxes on a Roth conversion is to spread out the payments equally over two years. You would not report the conversion during the current tax year, but then you would have to report it the next two years. You would divide the income into two equal parts and pay taxes on them. Most people choose the two-year tax option if they expect their income and tax rate to remain the same over two years' time.

Extend Your Decision Time

You are able to extend the time to make a decision on how you want to pay your Roth conversion taxes. To do this, you can file an extension on your taxes. Examine your income for the current year and figure out your tax bracket around October. The deadline for filing on extensions is mid-October. Keep in mind, though, that filing an extension only affects the date your filing paperwork is due; it does not delay the payment of your taxes. You still need to pay the taxes you think you will owe by April 15 or whatever other date by which you normally have to pay.

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