How to Calculate a Traditional IRA to a Roth IRA
Beginning in 2010, the Internal Revenue Service lifted all income restrictions on who could convert money from a traditional IRA to a Roth IRA. Some people have decided to convert from traditional IRAs to Roth IRAs because money can be withdrawn tax-free from a Roth IRA. The amount of your conversion is included in your taxable income for the year. To determine how much you will have to pay in additional taxes, you need to know your adjusted gross income and the tax brackets for the current year.
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Instructions
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You should calculate the portion of your Roth IRA conversion that will be taxable. If you had no nondeductible contributions in your traditional IRAs, the entire amount will be taxable. If you do, only the percentage of the conversion that comes from earnings will be taxable. For example, if your traditional IRAs are worth $100,000, with $20,000 in nondeductible contributions, 20 percent of your conversion will not be taxable. For example, if you were converting $20,000, only $16,000 would be taxable income.
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You should estimate your adjusted gross income for the year that you are making the conversion by subtracting any deductions and exemptions that you expect to be eligible for from your total taxable income, not including the Roth conversion. You will not know for sure how much your conversion tax will be until you file your official tax return.
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You should determine how much more income could be taxed at your current tax rate by subtracting your adjusted gross income from the upper limit for that tax bracket. You can find the most current federal tax brackets on the IRS website. For example, if you had $45,000 as your adjusted gross income and the 25 percent tax bracket ranged from $35,000 to $55,000 and the 28 percent tax bracket went from $55,0001 to $95,000, you would subtract $45,000 from $55,000 to find that you would have the next $10,000 taxed at 25 percent and the next $40,000 taxed at 28 percent.
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You should subtract the amount of money that you have before you enter the next higher tax bracket from the taxable portion of your conversion amount. If the result is zero or less, the entire amount of your contribution is taxed at that tax rate. In this example, you would subtract $10,000 from $16,000 to find that $6,000 is taxed at the next higher tax bracket.
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You should calculate your total tax on your conversion by multiplying the portion of your conversion that falls in each tax bracket by the tax rate. In this example, $10,000 would be taxed at 25 percent so you would multiply $10,000 times 0.25 to get $2,500. The remaining $6,000 would be taxed at 28 percent so you would multiply $6,000 by 0.28 to get $1,680. By Adding $2,500 to $1,680, it would show you that your total tax on the conversion would be $4,180.
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Tips & Warnings
If you will make about the same amount in the year that you convert the money from a traditional IRA to a Roth IRA, you can get a good idea of how much you will have to pay in taxes by adding the taxable amount of the conversion to your prior year's income tax return and seeing how much more you would owe in taxes.
References
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