Roth IRA Conversion, Tax bracket Jump?

Question

I make 63500 k and I have 39000 in an IRA that I would like to convert it to a Roth. My taxable income was 33056 this year and I will get about a 3% raise. I don't want to have the conversion bump me up to higher tax bracket. How much can I convert?

Answer 1

This is JUST an educated guess. I'd need to see your 2006 tax return to make a better estimate. It's based on your expected 3% raise and assumes that it kicked in on Jan 1, 2007 along with the exemption amount for 2007 ($3,400) and the 2007 standard deduction of $5,450.

Your 2007 gross income will be 65405. Assuming you take the standard deduction and are single with no dependents, your taxable income will be $56,555.00 if there are no IRA deductions in 2007.

Your marginal tax rate is 25%. The rollover point to the next bracket will be $77,100.00. That means that you could roll $20,545 into a Roth without moving to the next tax bracket. You'd pay $5,136 tax on that conversion.

However, don't let the tax bracket be your final determining factor. The next tax bracket only goes up to 28% and only the amount of taxable income over $77,100 will be subject to that higher rate of tax. The remaining $18,455 from your IRA would be taxed at 28% if you rolled the whole thing over. That's only an extra tax of $554 due to "bracket creep" compared to what the tax would be at 25%. You would probably get that back many times over with the extra tax-free earnings in the Roth over time.

If you roll the entire amount over, the tax on the remaining $18,455 would be $5,167 for a total tax bite of $10,303 to convert the IRA to a Roth. Remember, only $554 of that would be extra tax due to moving to the next tax bracket. It would probably cost you that much in aggravation just to re-crunch the numbers using your exact numbers. And keep in mind that you won't know the exact numbers until late December, 2007. The relatively minimal savings could be wiped out over time with the tax free accumulation in the Roth -- and who wants to go chasing tax calculations during the holidays anyway?

Answer 2

You'll need to visit with the bank where you want to put the new IRA. The problem is that the Traditional IRA is pre-tax money and the Roth is after-tax money, so you'll have to pay taxes on whatever amount you convert... that means you'll want to probably make estimated tax payments throughout 2007 if you convert much of this.

I seriously doubt that anyone other than a tax advisor can tell you the actual amount you'll want to convert because your individual tax rate will depend on other factors which will affect the tax return.

Answer 3

You obviously make enough that you should hire a CPA, rather than taking your chances on incorrect answers in this forum.

Answer 4

Call your financial advisor and ask them, I think that would be the most helpful tip.