How Is Roth Conversion Taxed?

You pay tax at the current rate. The Roth money can affect your marginal tax rates and underpayment penalties. It is treated just like any other "ordinary" income reported in the given tax year.

Ira Smilovitz Leonia, NJ

Paying at the 2011/2012 rates is actually a Good Thing, as the 2011 and

2012 inflation-adjusted amounts are higher than 2010, so more of your taxable income is taxed in the lower brackets compared to 2010, your standard deduction and exemption deduction is higher than in 2010, etc.

Plus, you've had (and will have) the free use of the tax money owed for one or two years.

The only potential downside, of course, is whether the Roth conversion itself was a good move, only time will tell. But you probably got the best deal possible to date on the conversion tax.

I didn't care for the 2010 deal. I prefer to advise a conversion that would top off the current bracket (if that's the wish) and keep the option to recharacterize if we overshot. For my retired MIL, it's no coincidence that her taxable income is exactly the line between 15 and

25% brackets. $100 less and she'd have $15 less tax owed, $100 more, $30 more tax owed. (Yes, $30. I think it was right where Social Security would start to get taxed, didn't really analyze to death). We've done this for years now, staying ahead of the increasing RMDs, the conversion actually accelerating not dropping.

The gain from the 2 year delay could easily have been lost had we miscalculated her income and tax rates for the 11 and 12 returns.

I was thinking more of the higher-bracket taxpayer. or one who wants to convert a certain amount no matter what. This might apply, for example, to someone who wants to get a set amount of money out of a Trad. IRA without penalty, well before age 59.5. Just convert and pay tax now, then wait five years to take conversions out of the Roth with no additional tax or penalty.

If you only convert as much each year as keeps you in your current bracket, that's one thing, you are defining your own "best deal" based on a variable (dependent) conversion amount. But if you convert a pre-determined amount (independent), then the 2010 default deal is better than any previous year (due to spreading income over two years, and using 2011/2012 inflation-adjusted brackets and deductions to pay tax on 2010 distribution).

Isn't it 5 years or 59.5, whichever is 'later'?

(I understand the rest. There are those already in the higher brackets, not playing the bracket game I'm focused on. Good point, every situation is unique, mostly)

Unfortunately, I misunderstood how the conversion would be taxed. Consequently, we now have not only two $100K bumps in our income but additional bumps because we have to sell assets to pay the additional taxes. Live and learn.

Thanks to those who responded. It really helped.

Gary

Nope, just five years for each conversion.

Don't know, but why on earth would you take money out of a Roth before you had to? Other than maybe a 529, it is the best investment on earth. A higher-bracket taxpayer shouldn't need the money THAT badly.

to? Other than maybe a 529, it is the best investment on earth.

Maybe a 50 year old is on track to retire at 55. The 5 year rule Mark cites is an opportunity to start his retirement distributions at 55 without the onerous math and tracking of Sec 72(t) distributions.

This is one scenario. People has reasons for doing what hey do, we're not judging, just spelling out the rules surrounding the actions they take. The above rule is a "good to know."

Yes, typos. Fixed. I'm too fast hitting 'send.'

to? Other than maybe a 529, it is the best investment on earth.

I don't think "tax treatment" (Roth/529) is equivalent to "return on investment". Or put another way, the tax tail shouldn't wag the income dog.

I try to diversify my tax-qualified retirement investments between traditional-style and Roth-style. I certainly do not think that a Roth contribution/conversion is a guaranteed good idea for many or even most people, especially when the same funds that went into the Roth at ordinary income tax rates might have been taxed at long-term capital gains rates instead.

I mentioned two categories: higher-bracket, OR one who wants to convert a certain amount no matter what. My example was one of the latter.

And given the fiscal position of the US, especially looking forward.

I will not be surprised if one or more of the following happen in the next 20+ years:

1) Roth distributions, while remaining untaxed, will count in the taxability of SS benefits calculation. 2) When Roth earnings are distributed, they will be an AMT preference item. 3) Roth distributions, while remaining untaxed, will count in AGI for purposes of itemized deduction limitations/haircuts, ability to take various credits, and for determining if you are subject to the Medicare tax on unearned income. 4) Roth earnings will become taxable on distribution (in other words, Roths will essentially be converted into non-deductible IRAs, except that after-tax money will still be considered to come out first unlike like the pro-rata rules applying to trad IRAs).

So I've become increasingly reluctant to consider trad -> Roth conversions that have a significant tax cost or Roth 401(k) contributions.

That said, I still think that if you've ever made any non-deductible trad IRA contributions and either have access to a solo 401(k) or a standard 401(k) (or other qualified retirement plan) whose investment choices you like, it's a pretty much a no-brainer to take advantage of the special treatment of rollovers from trad IRAs to qualified plans which allows you to roll over *only* the pre-tax money, leaving the after-tax money behind, which in turn allows you to convert that remainder into a Roth at zero tax cost.

All of these possibilities are a reaction (by congress) to the aggressive use of Roth in a way that favors the rich, among them, the pre-ipo stock in the Roth, which now is millions that isn't subject to even cap gains. I'm not one to shoot the messenger, especially when the message is a great warning. Rich, I agree that any/all of the above are potential risks to the current set of rules.

What's most unfortunate is that the above will snare the middle along with the real target of the rule changes. I'm thinking of those who strategically converted post-retirement but pre start of taking SS benefits. Trying to avoid the potential crazy effects of the 85% inclusion of SS for tax purposes. This creates a phantom 45%+ rate for retirees that are far from wealthy. Bad unintended consequence.