Question

Tatia, age 38, single taxpayer, has made deductible contributions to her traditional IRA over the past few years. When her account balance was $32,000, she transferred the entire $32,000 out of her traditional IRA and immediately into a Roth IRA. Her current marginal tax rate is 25 percent. What amount of tax and penalty is she required to pay on this rollover?

Answer 1

Tax impact.

When you convert a traditional IRA to a Roth, you will owe taxes on any money in the traditional IRA that would have been taxed when you withdrew it. That includes the tax-deductible contributions you made to the account as well as the tax-deferred earnings that have built up in the account over the years. That money will be taxed as income for the year you make the conversion.

Penalty impact.

Converting all or part of a traditional IRA to a Roth IRA is a fairly straightforward process. The IRS describes three ways to go about it:

1. A rollover, in which you take a distribution from your traditional IRA in the form of a check and deposit that money in a Roth account within 60 days.
2. A trustee-to-trustee transfer, in which you direct the financial institution that holds your traditional IRA to transfer the money to your Roth account at another financial institution.
3. A same-trustee transfer, in which you tell the financial institution that holds your traditional IRA to transfer the money into a Roth account at that same institution.

Of the three methods, the two types of transfers are likely to be the most foolproof. If you take a rollover and, for whatever reason, don't deposit the money within the required 60 days, you could be subject to a 10% penalty tax on early distributions in addition to the other taxes you'll owe as a result of the conversion. The 10% penalty tax doesn't apply if you are over age 59½.

Whatever method you use, you will need to report the conversion to the IRS using Form 8606 when you file your income taxes for the year.

As Tatia has immediately transferred the ira amount from traditional to Roth there will be no penalty impact and as mentioned above the ira amount will be taxed as income for the year in which you have made the conversion.

( $32000 minus deductions * 25% )