Roth IRA Conversions-In Plain English

A real deer in headlights, not my husband.

I was having dinner with my husband and was telling him that we needed to think about doing a Roth IRA conversion this year.  The more detail I went into, the further his eyes glazed over.  Finally, he waved his hand over his head and said, “You do the calculations and let me know if we should or not.”    He gets that way when I go into “tax speak.”   He’s not stupid either, he understands money, he has an MBA, but taxes tend to give him that deer in the headlights look.  I’m guessing he’s not alone.  Here’s my attempt at making it easy.

A regular IRA is money that you get a tax deduction for when you put the money in, but you pay taxes on it when you take the money out.  If you take the money out before you’re 59 1/2, you also pay a 10% penalty on top of the tax you pay for taking it out.

A Roth IRA doesn’t give you any tax deduction when you put the money in, but when you take it out there is no tax on the withdrawl.  The penalty, if you take it out early, is only on the earnings, not the main amount of money.  It’s usually very small.

The whole issue of Roth vs regular is Pay Now or Pay Later.  Normally I’m a “pay later” kind of person, but I like the benefits of the Roth so much that they often outweigh the disadvantage of Pay Now. 

So what’s a Roth conversion?  That’s when you have money that you put into a regular IRA and move it into a Roth IRA.  When you do that, you will have to pay tax on the IRA money, but you won’t have to pay the penalty. 

Why would anyone want to do that?  It’s back to pay now versus pay later.  It looks like tax rates will go up in the future.  Roth IRA money would be tax-free income during retirement and we all like tax free income!

Why is it a big deal now?  Normally, you can only convert to a Roth IRA if your income is less than $100,000 — that’s including the money being moved into a Roth IRA because that also counts as income.  For this year only, 2010, there is no income limit.  Anybody can play.

So what’s the catch?  If you do a conversion, you have to pay the tax.  You have two choices:  1.  You pay all of the tax on the conversion with your 2010 tax return, or 2.  You split the tax you pay into two equal installments with your 2011 and 2012 taxes. 

Once again, normally I’m a pay later person, but right now Congress hasn’t extended the Bush tax cuts yet.  Until we hear otherwise, tax rates are scheduled to go up for 2011.  I’d make my decision based upon paying it all in 2010.  If things change, then you’ve got options, otherwise, go for pay now.

Do I have to convert all of the money in my IRA to a Roth?  No.  Only as much as you want/can afford to. 

Do you think I should do it?  That depends.  The younger you are, the more inclined I am to say yes.   If you’ve ever put money into an IRA that you didn’t get a deduction for, I’m more inclined to say yes.    How are you going to pay the additional tax?  If you’re going to take it out of the IRA money you withdraw, then I’m definitely leaning against that.  If’ you’ve got it in savings, or have withheld extra and are just giving up a big refund, then you’re good.

Bottom line is:  as much as I like Roth IRAs and this is a once in a lifetime opportunity, it also involves paying more taxes.  If you have the cash and can afford to do it, I say go for it.  If you’re cash strapped already, it’s not such a good choice.

2 thoughts on “Roth IRA Conversions-In Plain English

  1. Hi Mark,
    I think you make a really great argument for moving to Texas!
    You have a couple of questions going: first, is it better to pay it all at once or to split paying into the next two years. I’ve done about four returns with ROTH IRA conversions in them and the clients have been split on that issue. Get it over with versus balancing the tax debt. I think if you’re at a point where the conversion puts you into a higher tax bracket (but splitting doesn’t) then definitely go with the split. Otherwise, it’s pretty much a personal decision as far as what your preference is.
    Then again, if there’s a serious possibility that you could be living in Texas again, then I’d defnitely do the split to avoid paying the California state taxes. (You’ll want to make sure that you make yourself a Texas “resident” and don’t just work in Texas as a “non-resident.” The resident state claims the income tax on pensions so make sure that you claim a Texas residency.)
    Remember, if you pay it all, that goes on your 2010 tax return. If you’re splitting, that goes on your 2011 and 2012 tax returns. For more information, I’ve got another post at
    Thanks for your comment. I am really liking the “move to Texas” idea. (I used to live there!)

  2. The Bush tax cut has been extended but the question is to pay at once or split the roth conversion tax?
    On top of this I now live in California and find it a total joke that they get to have free money given to them because I did the conversion here. I invested the original Traditional IRA money while in TX where there are no state taxes.
    The leads to the question of if I split the cost of the conversion tax and am not in CA the second year but back in TX then do I no longer have to pay state tax to CA?
    One final thing, if I do split the conversion cost then is that money added to my income as half one year and half the other so my tax bracket has a better chance of not jumping?

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