Taxes for IRA Rollovers to Roth

by Leslie McClintock

Roth IRA accounts have a number of advantages over traditional IRAs. First of all, you don't need to take required minimum distributions in retirement. You have already paid the tax on the money you contributed, so the IRS doesn't tax your withdrawals. Second, because you've already paid taxes, your taxable estate is smaller, which helps ease potential estate tax burdens upon your death. Third, you are essentially protecting yourself against the possibility that Congress will raise income tax rates between now and the time you retire. However, you should understand how the taxation on rollovers works prior to committing to rolling over a traditional IRA into a Roth.

Income Tax

When you roll a traditional IRA into a Roth IRA account, you must realize, or declare, any income you took out of the traditional IRA. You won't have to pay the usual 10 percent penalty expected of most people under age 59 1/2, though, provided you execute a trustee-to-trustee transfer, or complete the rollover within 60 days.

Income Limits

The old $100,000 income limit on IRA to Roth rollovers was lifted in 2010, which means that anyone, regardless of income, can roll traditional IRA balances into Roth accounts. However, the higher your income bracket, the higher your taxes will be on the conversion to a Roth IRA.

Considerations

Consider rolling IRA balances over to a Roth account if you are concerned about Congress increasing income tax rates in the future, if you want to lessen your exposure to potential estate taxes by paying income taxes now or you don't want to have to worry about taking required minimum distributions in retirement. Also, be careful about executing a rollover if you are near the top of your income bracket, and any new income will require you to pay a higher marginal income tax rate. If this is the case, you may wish to spread your rollover over several years to minimize the tax burden.

Filing

Income from traditional IRAs is taxable like any other income, except for that portion of your rollover attributable to nondeductible IRA contributions. When you execute a rollover, you are in effect taking a distribution from your IRA, and you will receive a Form 1099 from the investment company. You must include the amount of income on your 1099 in your gross income for the tax year in which you received it. This will increase your tax bill in the current year. You may wish to maximize your long-term tax benefits by paying the income tax with funds outside of the IRA, if possible.