Will a Roth conversion incur taxes?

Yes, it could. If you have pre-tax dollars (e.g., rollovers from a 401(k), deductible contributions, or investment gains) in any of your traditional IRAs (including SEP and SIMPLE IRAs), some or all of the converted funds are taxable as ordinary income for the year.

How much of my conversion is taxable?

To calculate how much of the converted amount is taxable, the IRS uses the following formula:

Taxable amount = [total pre-tax dollars in all your traditional IRAs] / [total dollars in all your traditional IRAs] * [converted amount]

To put that in more concrete terms, let’s run through some examples.

Example 1: You have one traditional IRA with $6,000 in post-tax money, and you convert all of it.

$0 / $6,000 * $6,000 = $0 taxable

If you don’t have any investment gains or deductible contributions (i.e., none of your IRA holdings are pre-tax), you wouldn’t incur any taxes from the conversion. 

Example 2: You have one traditional IRA with $6,000 in post-tax money and $100 in investment gains, and you convert all of it.

$100 / $6,100 * $6,100 = $100 taxable

If you convert your one and only traditional IRA, you’re simply taxed on the pre-tax money in that IRA (in this case the investment gains).

Example 3: You have two traditional IRAs:

  • A Wealthfront Traditional IRA with $6,000 of post-tax funds. 
  • A traditional IRA at another brokerage with $18,000 in pre-tax funds.  

You convert the full value of the Wealthfront IRA ($6,000).

$18,000 / $24,000 * $6,000 = $4,500 taxable

For tax purposes, the IRS treats all of your traditional IRAs as a single, aggregate IRA (this is sometimes referred to as the “pro-rata rule”). So even though you’re only converting post-tax funds, you incur taxes based on the percentage of pre-tax funds in all of your traditional IRAs. In this example, 75% of all your traditional IRA money is pre-tax, so 75% of your converted amount would be taxable. 

To learn how a Roth conversion would affect your taxes based on your personal situation (including state and local taxes), consult a tax advisor. Wealthfront is not a tax advisor, so this answer is for informational purposes only and should not be considered advice.

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