why does converting to roth ADD to net taxable income?

Submitted by Michael Disney on Mon, 2019-02-18 20:36

I fully realize converting a Traditional IRA to ROTH IRA is a ‘taxable event’ … but should the amount I’m converting be considered “INCOME” (eg., increases Line 7 ‘adjusted gross income’ which doubles or even triples my tax bracket!! I would consider this double-taxation!)

My thinking is the amount I convert remains in a retirement account that I can’t touch for 5 years so it shouldn’t increase my “line 7 gross income” … the tax rate/bracket should be based on ACTUAL income that I can spend on living expenses.

am I missing something? [besides ‘uncle Sam’ reaching deeper into our pockets!]



Submitted by Alan - IRA critic on Mon, 2019-02-18 21:03

  • There is never double taxation if you report correctly. If your TIRA is pre tax, you have not paid taxes on that money, but when you convert it to a Roth IRA, you will owe taxes at that time. But if you made a non deductible contribution to a TIRA and then convert that contribution, you will not owe taxes on the conversion, because the TIRA contribution had been taxed previously. So each dollar just gets taxed one time. If you have a Roth IRA that you hold until it is qualified (5 years and 59.5) any gains in the Roth IRA will be tax free, so those dollars never get taxed.
  • Line 7 on the new 1040 is adjusted gross income, but your taxes are calculated on your taxable income after you take your standard or itemized deductions. However, a taxable conversion will add to line 7 because when you convert you are paying current taxes to change your IRA type from TIRA to Roth. The TIRA is taxed when you take distributions, and the Roth is not. When you convert you are therefore paying taxes at that time in exchange for never having to pay taxes again on the Roth IRA distributions. And you also do not have to take out RMDs when you reach 70.5 from a Roth IRA.
  • A conversion is beneficial if the taxes you owe are less than the rate you think you will pay in retirement or whenever else you would want to take a distribution. But if you are in a higher bracket when you are working you would not normally convert at that time, you would wait until your bracket is lower (or not worse than equal to) than what you expect in retirement. A conversion is a choice that you should do if you expect to benefit long term. You do not have to convert at any time, so you should only do so if you expect to benefit from it. Note that tax rates are lower now than they probably will be in the future, so converting some amounts is probably wise if you think you will accumulate a large retirement plan balance eventually. Conversely, if you think your health is likely to be poor, your employment future is not looking good, or you want to retire early which will prevent you from saving too much, then conversion is not a good idea.

Submitted by Michael Disney on Tue, 2019-02-19 17:15

Thanks very much for the detailed response … I understand paying the taxes now in order to not pay them later – which I think is a ‘decent’ option.  However, my concern really boils down to the ‘type of distribution’ as recorded on the 1098.  I had 3 “normal distributions” which I took as my ‘pay’ or ‘pension’ (as it’s intended).  BUT, I also have 4 conversions (TIBA to ROTH) which did not come to me as ‘pay’ or ‘pension’ – they remained in the retirement account (well, moved to the Roth acct).  Therefore, the tax RATE (based on taxable [spendable] income – eg., taxable ‘pay’ or ‘pension’) should be applied to the conversion, at least in my mind.  Here’s the example:’normal distribution’ totals $100K.    ‘conversioni distribution’ totals $200K.this mean the IRS “thinks” I earned $300K in income and therefore taxed at the 32% bracket … but I never TOUCHED the $200K … so my $200K SHOULD be taxed at the $100K bracket, representing the ACTUAL monies distributed to me in the form of ‘cash’, which is my current tax rate!  I should NOT have to pay taxes at a DOUBLE rate – the whole point  for converting is to pay the taxes on the CURRENT tax rate, when it is expected to be “lower” … not one that is artificially inflated!  So final question … the ‘type’ on the 1098 is “7” which is “normal distribution”.  Is there a “conversion distribution” type that would take all this into consideration? thanks again.

Submitted by David Mertz on Tue, 2019-02-19 19:06

  • A traditional IRA contains deferred income.  When distributed from the traditional IRA and not rolled over to another traditional retirement account, the income is realized in the year of the distribution.  Converting to a Roth IRA does not change the fact that the income has been realized and adds to your AGI.
  • People often manage the marginal tax rate on a Roth conversion by converting no more in any one year than the amount that would bring their ordinary taxable income to the top of their current tax bracket.

Submitted by Alan - IRA critic on Tue, 2019-02-19 19:26

Note that the 1099R (not 1098) distribution code of 7 indicates you are over 59.5. As such there is no 5 year holding requirement for withdrawing the converted amount tax and penalty free. But until 5 years passes from the year of your first Roth IRA contribution (regular or conversion) any gains in the Roth will be taxable. It should be easy enough to limit withdrawals to the converted amounts plus any regular Roth contributions you made until you meet the 5 year holding period. Also, there is no other distribution code for a conversion that would affect how the conversion is taxed. It’s taxed in the same manner as if you received W-2 wages of an equal amount, but of course no SS or Medicare taxes are due.

Submitted by Michael Disney on Wed, 2019-02-20 16:01

thank you…

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