taxes

Take tax control of your IRA conversion

For example, you have $10,000 in a traditional IRA but cannot afford to pay taxes on that full amount. You do, however, have enough cash from non-IRA sources to pay for a $1,000 conversion. By moving that amount from your traditional IRA to a Roth, the extra grand will be added to your 2007 income when you file your return next year.

Let's say that in 2008, you receive a large bonus that will push you near the top of your current tax bracket. To keep from going into the next higher one, you decide not to convert any IRA money that year.

Then in 2009, you buy a house and are able to itemize deductions for the first time. Because your home-related deductions will help lower your taxable income, you decide to transfer $5,000 more from your traditional account to your Roth IRA.

Just make sure, though, that your new 2009 income level doesn't pose other tax problems.

Yes, your tax bill, even with the additional income, might be essentially the same as in prior years, thanks to your new itemized deductions. But the extra $5,000 from your IRA will increase your adjusted gross income, and that larger figure could keep you from claiming some credits or deductions, says Bogue.

Sorting out commingled money

In addition to determining a traditional-to-Roth schedule, you must also make sure you know precisely how much of your converted money is taxable.

The tax consequences of conversion are easiest, administratively, if not on your pocketbook, if you made only deductible contributions to your traditional IRA. In this case, you'll owe taxes on all the money, contributions and earnings alike, that you move into a Roth.

Some individuals, however, have a mixture of deductible and nondeductible money in their traditional IRA. Take the case of Janet, who opened a traditional IRA when she began her first job 20 years ago. Her small employer didn't offer a retirement plan, so Janet decided to save on her own and get the advantage of deducting her IRA contributions.

Janet invested in the IRA regularly, even after she changed jobs and her subsequent employers all offered retirement plans. She decided that the more she could put into all available retirement options, the better.

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When the Roth IRA appeared in 1998, Janet considered converting her original traditional account to the new version, but by then her career had progressed nicely and she made too much money to qualify for a Roth account. Right now, if you make more than $100,000 -- and that amount applies to single taxpayers as well as married couples filing joint returns -- you can't convert your traditional account to a Roth. (A law enacted in 2006 will remove this earnings limit; more on that later.) Couples can't circumvent the earnings cap by filing separate returns; conversions are not allowed for couples filing separately.

Now Janet has moved to part-time work, with no company retirement plan and earnings that meet the Roth guidelines, and she wants to convert her traditional IRA. Because her account contains her early deductible contributions and many years of nondeductible ones, she needs to figure out just how much of the money in her old IRA will be taxable when she moves it to a Roth.

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