A Roth IRA is similar in some respects to a traditional IRA, but with different tax characteristics. Depending on your financial situation, converting your traditional IRA to a Roth IRA might make sense. However, you'll face tax consequences as a result of any conversions to a Roth IRA. If your state has a personal income tax, as the state of California does, you may also owe additional state taxes on your Roth conversion.
A Roth conversion is considered taxable income, both to the federal government and the state of California, due to the tax treatment of IRA contributions. When you put money in a traditional IRA, you generally get a tax deduction, and then the account grows tax-deferred as well. In other words, the money you take out of a traditional IRA has never been taxed. As a result, it all becomes taxable as income upon withdrawal. Roth IRA contributions, on the other hand, are made with after-tax money, but then your distributions are typically tax-free. Converting from a pre-tax account, like a traditional IRA, to an after-tax account, such as a Roth IRA, results in a tax liability -- you must pay income tax on the money you withdraw and place in the Roth.
Federal Income Tax
To complete your California income tax, you'll have to transfer certain information from your federal tax return. All of the income you list on your federal tax return, less certain deductions, filters down to your "taxable income," which you need to provide on your California return. The federal government considers a Roth conversion to be federally taxable income, so the amount of the conversion is part of your total taxable income. While you don't have to list the amount of the Roth conversion as a distinct line item on your California return, it is already part of your taxable income: it therefore transfers as a taxable item on your California return.
California Tax Rates
The amount of California tax you'll have to pay on your IRA conversion depends on the total amount of taxable income you have for the year. Like the federal government, California has a graduated tax system. The more you earn, the higher the tax rate you'll pay. As of 2011, the highest California tax rate was 9.3 percent, for married taxpayers with taxable incomes of $96,058 or higher. If you were in the highest California tax bracket and converted $100,000 to a Roth IRA, you'd owe an additional $9,300 in California income tax.
Although the money you later withdraw from your Roth IRA is tax-free, the amount of tax you have to pay at the time of your conversion might outweigh any future benefit. You'll also have to come up with the cash to pay the taxes on the conversion.
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