Should I Pay Taxes Now or Later for My Roth IRA?

Wendy Shick | March 30th, 2011

If you took advantage of last year’s law change allowing you to convert your IRA to a Roth IRA, you face a big all-or-nothing tax payment decision on April 18: pay the taxes on your pretax contributions and gains in 2010, or split the tax bill between 2011 and 2012.

The opportunity to defer the tax payment was limited to Roth IRA conversions made in 2010. So, if you converted an IRA to a Roth during 2011, you’ll have no choice but to pay taxes on the income when you file your 2011 tax return.

For many taxpayers, deferring the payment might be an easy choice. What’s not to like about being able to defer the tax into two payments at no additional cost?

However, depending on your circumstances, it might make sense to pay a lump sum in 2010. For example, if you were unemployed in 2010 and now back to work, your 2011 tax rate might be higher – making it more advantageous to pay the tax in 2010.

There is one other way you can hedge your bet on the conversion. If you file for an extension on your taxes, you have until Oct. 15 to decide if the conversion is, in fact, the best route for you. The extension also gives you time to analyze how your 2011 income level will compare with 2010.

And with today’s volatile stock market, the extension will allow time to determine if those assets you converted are worth less by fall than when the IRA was converted.

If you converted your traditional retirement account into a Roth IRA last year, be sure to talk to your tax professional about benefits and detriments of paying now or paying later.

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