Q&A: Paying Taxes After a Roth IRA Conversion - Ask Encore @ WSJ.com

Ask Encore @ WSJ.com 
Focus on Retirement - By KELLY GREENE

Q: In 2010, when the income limits are lifted for converting a traditional IRA to a Roth IRA, my wife and I plan to convert about $50,000 in traditional IRAs. We plan to pay the taxes with funds from outside the IRA and also to pay them all in the 2010 tax year.

Our question is this: At what time during the 2010 tax year are the taxes due? For example, if we convert in January 2010, do we need to pay estimated taxes for first quarter of 2010 by April 15, 2010? Or can we wait to pay the taxes until we file our 2010 taxes in March or April of 2011—without incurring a penalty for being "under-withheld"?

If we would need to pay quarterly estimated taxes, it would probably cause us to defer the conversion until the fourth quarter of 2010, and thus not owe the taxes until 2011.

—Paul Sklar Pittsburgh, PA

A: You're ahead of the game, because many people have no idea that converting assets to a Roth IRA could affect the timing of their tax payments.

To review: Effective Jan. 1, 2010, the federal government is permanently dropping the income limit for transferring savings to a Roth IRA from a traditional individual retirement account or employer-sponsored retirement plan. Although such conversions will be subject to income tax, future withdrawals (that meet holding requirements) would be tax-free.


One important thing to think about in terms of timing: Delaying a Roth conversion until the fourth quarter of next year might help you delay paying the tax involved; but if your IRA has fallen in value in the past few years, you may want to convert the account as soon as possible next year, before its value recovers further, to keep the tax bill as low as you can.

"What have you accomplished if the value of the IRA goes up in that time and you pay tax on it?" says Barry Picker, a certified financial planner and certified public accountant in New York. "It could have been in a Roth growing tax-free."

Adds Lester Law, national wealth strategist for U.S. Trust, Bank of America Private Wealth Management: "This is not a tax payment decision; it's an investment and estate-planning decision. Don't let the tax tail wag the dog."

Generally, you have three options for paying income tax throughout the year, and thus avoiding a penalty and interest for underpayment of your income tax.

1. The first is to pay 100% of last year's tax, or 110% of last year's tax if your adjusted gross income is over $150,000 for individuals or for married couples who file joint tax returns. This method is the one most commonly used and it will probably work for most people who plan to pay any income tax for a 2010 Roth conversion as part of their 2010 tax return, Mr. Law says.
   
   
2. The second option is to pay 90% of the current year's tax, which is something that people who convert a large amount to a Roth in 2010 may want to consider doing in 2011 as a way to lower the tax amounts that they pay quarterly or have withheld from their paychecks, he says.
   
   
3. The third option is to estimate your income each quarter and pay tax on it for that quarter, Mr. Law says.

As for the mechanics of actually making the payments: You can have the tax withheld from your paycheck; you can make quarterly payments (actually due April 15, June 15, Sept. 15 and Jan. 15); or you can do a combination of both, Mr. Law says.

One Other Note: Conversion income might drive up your state income taxes as well. To get a definitive answer for a specific state or local government, you should check with a local accountant.

Write to Ask Encore at encore@wsj.com