I want to do a Roth conversion from my traditional IRA in the amount of $250,000. It’s my understanding that I have to pay the income tax on the $250,000. Can that tax be paid from the funds in the IRA or do I have to pay the tax outside of the IRA?
– Kevin
This one is straightforward. The IRS doesn’t care where the money comes from. As long as you cut them a check they’ll be happy!
All kidding aside – yes, the $250,000 is included in your gross income. You can pay the tax bill using either the converted funds or money from other sources, but the difference is potentially substantial. You may want to consider using non-IRA funds to pay the tax bill if it’s an option for you.
A financial advisor can help you make important retirement planning decisions, like when to do a Roth conversion and in what amount. Connect with a financial advisor.
To understand the tax implications of a Roth conversion, it’s helpful to think about what this type of transfer does. A Roth conversion allows you to move money from a traditional, tax-deferred retirement account into a Roth IRA.
The main idea behind tax-deferred retirement accounts is in the name. When you contribute to a traditional IRA, 401(k) or similar account, you get to deduct that amount from your current gross income, thereby avoiding the tax liability for that year. Instead, that tax liability is deferred until you withdraw the money from the account. This deferral also applies to the growth, dividends and interest the money earns.
Typically, this tax bill comes due when you start making withdrawals in retirement. However, moving that money into a Roth IRA also removes it from the account, triggering income taxes. Assuming that you made deductible contributions (not non-deductible contributions) to your IRA, the converted funds are added to your gross income for the year and increase your tax liability. (A financial advisor with tax planning expertise can be a valuable resource as you make important financial decisions, especially around retirement.)
SmartAsset and Yahoo Finance LLC may earn commission or revenue through links in the content below.
You can pay the tax bill on a Roth conversion using a portion of the converted balance or money you have outside of your IRA. Here’s a closer look at the two options:
As a practical matter, many people rely on the converted funds to pay the income taxes on the conversion. If you don’t have money outside of the IRA to cover the taxes, this may simply be your only option. If that’s the case you can normally have the financial institution withhold the money when they do with conversion.
