When you perform a Roth conversion, the amount you convert from a traditional IRA or 401(k) to a Roth IRA is generally treated as ordinary income for tax purposes in the year of the conversion. This means the converted amount is added to your other taxable income for the year, and you pay taxes on it at your regular federal income tax rate.
Understanding How Roth Conversion Tax is Calculated
The exact amount of tax you will pay depends on several factors, primarily your total taxable income for the year of conversion and your filing status. Since the converted amount is added to your income, it can potentially push you into a higher tax bracket for some or all of the converted funds.
Here are the federal income tax rates that apply to ordinary income, which includes Roth conversions:
Federal Tax Rates for Roth Conversions
| Taxable Income (Single Filers) | Taxable Income (Married Filing Jointly & Surviving Spouses) | Federal Tax Rate |
|---|---|---|
| $0 - $11,925 | $0 - $23,850 | 10% |
| $11,926 - $48,475 | $23,851 - $96,950 | 12% |
| $48,476 - $103,350 | $96,951 - $206,700 | 22% |
| $103,351 - $197,300 | $206,701 - $394,600 | 24% |
| (Higher brackets apply for income above these amounts) |
It's important to note that these are marginal tax rates, meaning each portion of your income is taxed at the rate for its respective bracket. For example, if you are a single filer with $50,000 in taxable income, your first $11,925 is taxed at 10%, the income between $11,926 and $48,475 is taxed at 12%, and the remaining portion of your income (from $48,476 to $50,000) is taxed at 22%.
Practical Considerations for Calculating Your Tax
To determine your specific tax liability for a Roth conversion, consider the following:
- Total Annual Income: Add the amount you plan to convert to your estimated annual income from all other sources (salary, investments, etc.).
- Deductions and Credits: Factor in any deductions you plan to take (standard deduction or itemized deductions) and any tax credits, as these will reduce your total taxable income.
- State Taxes: Remember that in addition to federal taxes, many states also impose income taxes, which would apply to your Roth conversion as well.
- Taxable vs. Non-Taxable Conversions:
- Pre-tax funds: If the funds you are converting are from a traditional IRA that was funded with pre-tax contributions (e.g., deductible contributions or employer 401(k) contributions), the entire converted amount is typically taxable.
- After-tax funds (Basis): If you have already paid taxes on some of the money in your traditional IRA (known as "basis" or non-deductible contributions), only the portion of the conversion that represents pre-tax contributions and earnings will be taxable. You'll need to use IRS Form 8606 to track your basis.
Strategic Implications of Roth Conversions
Because Roth conversions trigger an immediate tax liability, they are often considered strategically based on your current and projected future tax situations:
- Current vs. Future Tax Brackets: A key reason to convert to a Roth IRA is if you believe your tax bracket will be higher in retirement than it is today. By paying taxes now, your qualified Roth distributions in retirement will be entirely tax-free.
- Future Growth: The earnings on your Roth account grow tax-free, and qualified withdrawals are also tax-free, making it a powerful tool for long-term wealth accumulation.
- Timing Conversions: Individuals often consider partial conversions over several years to avoid pushing too much income into higher tax brackets in a single year.
Calculating the exact tax for a Roth conversion requires assessing your complete financial picture for the year of conversion.
