If you're like most taxpayers, anything you contribute to a traditional IRA cuts your taxes. A thousand dollars in your IRA is usually a thousand dollars you don't pay tax on. If your marginal income tax rate is 25 percent, making the contribution cuts your taxes by $250. As of 2013, you can contribute up to $5,500 a year to your IRA, or $6,500 if you're 50 or older.
If you're covered by a retirement plan at work -- such as a 401(k), SEP-IRA or pension -- you may get less of a deduction. As of 2013, you start losing the write-off if your modified adjusted gross income on a joint return tops $95,000. At $115,000, there's no deduction at all. Other filing statuses get different cut-offs. You can still contribute $5,500 to your traditional IRA, but you'll have to pay income tax on some or all of the money.
If your MAGI is between $95,000 and $115,000, you have to figure what percentage of your contribution is tax-deductible. Subtract your MAGI from $115,000, then multiply the result by 25 percent. If your MAGI is, say, $105,000, the final result is $2,500. Any contributions above that are regular taxable income and have no effect on your tax bill. If you have a different filing status, the number will be different from this example, but the principle is the same.
If you make contributions to a Roth IRA, it doesn't affect your taxes at all. Everything you put in a Roth consists of after-tax money, and the tax break comes later, during retirement, when withdrawals are tax-free. If you transfer assets from a regular IRA or a 401(k) to a Roth, it's going to increase your tax bill for the year. Transferring $30,000 from a traditional IRA, for instance, requires paying tax on the money you transfer -- in other words, you must change its status from "pre-tax money" to "after-tax" money, so your tax return for that year will reflect an extra $30,000 in income.
If you have after-tax money in your IRA, you don't pay tax on it when you convert it to a Roth, but you do pay on the interest it's earned. You don't get to transfer just the taxable or tax-free part of the account. If, say, 30 percent of your traditional IRA consists of after-tax contributions, 30 percent of your transfer is tax-free. If you have multiple IRAs, you must calculate the overall percentage of tax-free money and use that figure to determine what's tax-free. For example, if the one IRA has $60,000 with 60 percent tax-free -- $36,000 -- and your second IRA has $40,000 with 20 percent tax-free -- $8,000 -- you have a total of $44,000 of tax-free money in $100,000 worth of IRAs, which is 44 percent. Any conversion, transfer, or withdrawal you make, from either account, is 44 percent tax-free.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.