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Roth IRA conversion costs

By Kay Bell ·
Tuesday, July 20, 2010
Posted: 9 am ET

If you're thinking of converting your traditional IRA to a Roth retirement account, you are definitely not alone.

This year, anyone can change a regular IRA -- the kind that might give you a tax deduction upfront but upon which you'll owe taxes when you finally start taking distributions -- into a Roth IRA. A Roth is a great option for many folks, primarily because there won't be any tax on withdrawals.

Before 2010, if you made $100,000 or more (married or single) you couldn't convert a traditional IRA to a Roth. Now, and in future years, that income limit is gone.

So are higher-earning IRA owners taking advantage of the conversion opportunity? Anecdotal evidence indicates yes.

TaxVox, the blog of the Tax Policy Center, reports that so far this year there's been a "quiet explosion" in Roth conversions. Vanguard and Fidelity say there's been tremendous interest in turning traditional retirement savings into tax-free accounts, particularly among the financial firms' wealthier clients.

This is just what Congress wanted when they created this option. When you change a traditional IRA into a Roth, you'll owe taxes on the earnings. That's because in exchange for eventual tax-free distributions, the dollars that go into a Roth are taxed upfront.

When the projections were made on what the Treasury might get from Roth conversions, the Congressional Budget Office calculated around $6.5 billion in new taxes from 2010 through 2015. That figure, however, might now be more front loaded.

The conversion option also offers you the chance to delay your tax bill on the switch into the 2011 and 2012 tax years. But those wealthy investment company clients who are converting might be better off paying all the due tax on their 2010 return. Why? This year the highest possible tax bracket is 35 percent. But thanks to the sunset of tax provisions, the top rate in 2011 will go to 39.6 percent ... or higher.

So Uncle Sam still might get a lot of new tax money on Roth conversions, but some of it will be at lower rates.

And even if some of the associated conversion costs arrive at Treasury in subsequent, higher-bracket tax years, some estimates put the potential loss of revenue through 2050 from all these new tax-free retirement accounts at around $100 billion.

Have or are you converting your old taxable IRA to a Roth this year? If so, when are you planning to pay those conversion taxes? Managing your retirement plans is just one midyear tax move you should be considering right about now.

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July 21, 2010 at 12:06 pm

Actually, i mistyped how much I would owe. My initial contribution to the rollover IRA was 13500 (it's up to 17500 now). Last years AGI (married, file jointly) was around 127500 with the taxable income being around 82500. My tax was 13000. does that means my tax bracket is 15%?

If so, does that mean i would only owe 15% tax on the 13500 (or $2025)?

Even if it's a small number, i have to think if i would have enough money $1000 a year extra to pay.

Kay Bell
July 20, 2010 at 7:37 pm

ngan, I totally agree. With the economy like it is, I want to keep my cash handy, not in the IRS hands right now!

July 20, 2010 at 1:29 pm

I don't think I will convert my rollover IRA to a Roth because of the taxes owed. Even though I can spread the payment over two years, i will still own 11k in taxes. that's alot to have to pay for something i can't use today.