Taxes with Traditional to Roth IRA conversion?

Question

I had opened a Traditional IRA last April contributing for the prior year, then continued contributing throughout the year and then converted to a Roth in January 07 and continued my montly contributions towards the prior year. How will this effect on how I file my taxes?

Answer 1

As of December 31, 2006 you had a traditional IRA. Take the deduction for contributions made through December 2006 that were designated for 2006 (the May through December payments).

In order for you to be able to make contributions to the converted Roth for 2006, the conversion had to occur by December 31, 2006. The payments you made after December 31,2006 to your Roth will not apply to 2006. They are 2007 contributions. If you need the full traditional IRA deduction, you will have to recharacterize the Roth, and then reconvert it.

The taxes due for the amounts converted in 2007 will be on your 2007 tax return. Since you have one full year of contributions for 2005, and 8 months for 2006, your converted amounts aren't going to generate a large tax bill. You could plan to owe those taxes, or adjust your payroll withholding a bit to cover them.

Answer 2

You'll need to pay taxes on the IRA for 2007. This is because the taxes on the Traditional IRA are deferred, while the Roth IRA is for after-tax income. You'll come out ahead in the long run, though, because when you retire and start drawing on the Roth IRA, most of the taxes will have already been paid on it. A lot of seniors are finding that a large portion of their Social Security retirement is taxable to them because of their IRAs and are having to pay tax on the SS and IRA incomes. Also, with Roth IRAs, once you've held them for 5 years, you can make withdrawals without the early withdrawal penalty, no matter what your age is.

For 2006, which is the return you'll file this year, the contributions to the traditional IRA will reduce your taxable income.

For 2007, which you'll file on next year, there will be some taxes to be paid in on the IRA conversion. I suggest you think about making some estimated tax payments on a quarterly basis throughout the year. It isn't absolutely necessary to make these tax payments, but it should make tax time in 2008 much, much less stressful.

Hope this helps.

Answer 3

You get a deduction for contributions to a traditional IRA if you and your spouse do not participate in an employer plan or if your AGI is below certain levels. In 2006, if you participate, you get the full deduction if your AGI (with a few modifications) is less than $75K and you are married or less than $50 and you are single. If you don't participate but your spouse does, you get the full deduction if your AGI is less than $150,000. If parts are non deductible, you need to fill out part I of form 8606 and file it with your 2006 return.

If you rolled over your traditional IRA to a Roth IRA in Jan 2007, you still get the same deduction in 2006. However, you have to recognize as income in 2007 the amount you rolled over, less the amount that was not deductible when you made the contribution. When you file your 2007 return you will need to fill out part II of form 8606 and file it with your return.

This assumes that you are allowed to make a Roth conversion in 2007. If your AGI exceeds $100,000 then the conversion will have to be reversed.

You get no deduction for Roth IRA contributions. You can make them if your AGI is less than $95,000 if you are single and $150,000 if you are married.