Looking for Explanation of Roth Conversion Tax Penalty.

[Guest jmwskw]

Could someone please explain to me in plain and simple terms what taxes I would owe in the following scenarios:

1. I transfer $2000 out of my traditional IRA (currently worth $14K) and use that to open a separate Roth IRA for myself.

2. I take $2000 out of a non-retirement mutual fund account and set up a separate Roth IRA for myself.

Exactly how much in taxes would I have to pay in each scenario. I am currently married, filing jointly in the 28% tax bracket.

A simple explanation would be greatly appreciated since I'm very confused as to which would be the best route to go. We can't afford a big tax bite, but really want to set up Roth's for ourselves to invest in. Can you set up a Roth IRA with an amount less than $2,000. I know that's the maximum individual limit.

Thank you.

[Kathy]

The answer to your first question depends on whether or not you ever made non-deductible contributions to your traditional IRA or not. If you have never made non-deductible contributions to your IRA, then you will simply add the $2,000 distribution from it to your ordinary income and pay taxes on it at your highest rate (you indicate 28%) - keeping in mind that it may bump you up into a higher tax bracket and therefore part of it may be taxable at a higher rate. If you have ever made nondeductible contributions to an IRA, then a portion of the distribution will be treated as a non-taxable distribution of your basis and the rest will be taxable. There is no 10% penalty on amounts properly converted to your Roth IRA.

Also, your modified adjusted gross income on your joint tax return must be under $100,000 to do this. The additional taxable $2,000 may also increase your state taxes and may reduce your ability to take other certain tax deductions.

If you take $2,000 out of a mutual fund account, you may have to pay taxes on any capital gains related to that redemption. If your joint modified adjusted gross income is under $150,000 you can do this.

It sounds like you may want to consult a tax advisor or find a good certified financial planner in your area who can help you take a look at your whole situation.