How should I pay tax on a Roth IRA conversion?


Q. I have read that, unless you have available cash to pay the taxes on the Roth IRA conversion, it doesn’t make sense to convert. Is this true and are there any circumstances when it might make sense or be acceptable to pay the taxes from the IRA itself?
— Investor

A. Let’s take a closer look at converting a traditional IRA to a Roth IRA.

When you convert, you are voluntarily paying the income taxes on your IRA now so it will grow tax-free in the future.

People who convert a traditional IRA to a Roth do so because they believe they are in a lower tax bracket now then they will be when they are retired, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.

Indeed, most people are in a higher tax bracket when they are working than when they are retired, he said.

“Conventional wisdom says the most efficient way to convert a traditional IRA to a Roth IRA is to pay the required income tax out of a taxable account and not from the IRA itself,” Kiely said. “The reasoning for this is you want to have the most amount growing tax free in your Roth IRA.”

He offered this example:

Let’s assume you are married and have $100,000 in taxable income for 2021. This puts you at the bottom of the 22% income tax bracket. You have $500,000 in an IRA and you wish to convert $100,000 of it to a Roth. The additional federal income taxes on your $100,000 Roth conversion will be $22,545. Part of your conversion will be taxed in the 22% and 24% income tax brackets.

“If you have sufficient funds in a taxable bank account to pay the taxes you will have $100,000 in your Roth account growing tax free,” he said. “If you can’t cover the tax then you would have to have $22,545 withheld from the IRA and only $77,455 would wind up in your Roth.

One circumstance that would justify paying the taxes out of the IRA would be if you are very young, and you anticipate coming into a huge windfall such as a large inheritance, and you are going leap into the much higher tax brackets for the rest of your life, he said.

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This story was originally published Oct. 6, 2021. presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.