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IRA, Roth conversions have varying tax implications

In your recent example about a person in the 25 percent tax bracket converting $100,000 from a tax-deferred IRA to a Roth IRA, you suggested paying the $25,000 tax out of the tax-deferred account. But won’t you have to withdraw more than $125,000 from the tax-deferred IRA to cover the tax on the extra $25,000? Another question: If you’re older than 70 12, how does a Roth conversion affect your required minimum distribution? One situation you didn’t mention is that doing a Roth conversion can give you the income to use excess tax deductions. For example, my elderly father-in-law’s medical deductions exceed his income. He doesn’t owe income taxes, and those deductions are wasted. It made sense to convert enough from his IRA to a Roth to take advantage of the medical deductions, and still allowed him to pay no taxes.

Several readers pointed out that paying the conversion tax from your tax-deferred account will boost the total tax on a Roth conversion. They’re right. I withdraw my earlier suggestion. It’s best to pay the tax from a non-retirement account. And as I wrote earlier, to recoup the cost of the conversion as fast as possible, you should deposit the entire withdrawal from your tax-deferred IRA into the Roth.

There’s no age limit on Roth conversions. But if you’re older than 70 1⁄2, you must take your annual RMD before withdrawing additional funds to convert to a Roth. In other words, you can’t convert your RMD.

Any year in which you’ll have unusually large tax deductions is an excellent year to consider doing a Roth conversion. Even if the deductions don’t eliminate your tax on the conversion, they may offset enough of it to keep the tax in a lower bracket.

THE BOTTOM LINE Consult your tax adviser before doing a Roth conversion.


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