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Be Aware of These Tax Issues Before Converting to a Roth IRA

by
Gordon W. McNamee
on
3/28/2022
Be Aware of These Tax Issues Before Converting to a Roth IRA

Are you considering moving your money from a traditional IRA to a Roth IRA?  Converting from one to another is a good way of minimizing taxes, as the earnings you eventually withdraw from the Roth will be tax-free when you're retired, while the money that sits in a traditional IRA will eventually be taxed. 

Though contributions to Roth IRAs aren't available to everybody because of income limits, those shut out of their tax benefits can skirt their ineligibility by first investing in a traditional IRA and then eventually converting from one to the other. This maneuver is sometimes known as a “backdoor Roth IRA,” and though there are significant benefits to pursuing it, there are some tax issues that will arise from withdrawing funds from your traditional IRA that you need to be aware of and prepare for beforehand. The more aware you are of the impacts, the better you can plan ahead.

  • When you take money out of your Roth IRA, you're going to owe the IRS on the pre-tax deposits that you originally made. 
  • The income that is generated by liquidating funds from your traditional IRA will boost your adjusted gross income. Not only will this trigger additional taxes, but it may also make you ineligible for some of the write-offs that you would otherwise be able to take advantage of, including student loan interest deductions or the child tax credit.
  • Traditional IRA owners who are (or who are approaching) Medicare age need to be aware that adjusted gross income has a direct effect on the cost of the monthly premiums you will pay for Medicare Part B and Part D. These costs are calculated based on modified adjusted gross income from two years earlier, so expect to see the impacts down the road. 

Do these hidden costs have enough of an impact to make a conversion a bad idea? Not necessarily, and especially not if you plan ahead and take advantage of market conditions to offset the costs. For example, if you time your withdrawal of funds from your traditional IRA around a market downturn, it will reduce the earnings that you will be taxed on, and your conversion may also occur at a time when shares are low. You can also balance the boost to your adjusted gross income by making a charitable contribution, by selling off stocks you own that are down and taking advantage of the capital losses, or by making contributions to other tax-advantaged accounts such as a 401(k) plan offered by your employer.

For more information on how strategic tax planning can help you hold on to more of your cash, contact a tax professional.

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Gordon W. McNamee

Gordon W. McNamee

Gordon W. McNamee is a Certified Public Accountant (CPA) based in Rancho Cucamonga, CA. Gordon W. McNamee can assist you with your tax return preparation, payroll, accounting and tax planning needs. <br /> <br /> 2021 is Gordon W. McNamee, CPAs 38th year in the profession. As as a former IRS agent (1984 through 1987), Gordon has been in public accounting since 1987. Gordon specializes in individual, corporate, HOA, trust, estate and payroll taxes. He also prepares financial statements and provides accounting & bookkeeping services. He enjoys making his clients feel at ease while providing a personalized professional service.

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