Converting a regular IRA to a Roth IRA can be expensive. When you convert a $300,000 IRA, for example, you’ll pick up an extra $300,000 in taxable income that year and owe around $120,000 in tax.
If you’re younger than 59-1/2 and take $120,000 from the Roth IRA, to pay the tax, you’re subject to the 10% early-withdrawal penalty tax. That would mean paying an extra $12,000 (10% of $120,000), perhaps from your Roth IRA. To avoid this penalty: Pay the tax from other funds. If you leave your Roth IRA intact for at least five years, no penalty will be due.
Instead of converting a $300,000 all at once, convert $50,000 per year for six years, staggering the tax bills. Wait until you’re 59-1/2 to convert. The penalty won’t apply. Borrow from a home equity line of credit to raise the money for the tax bill. Interest rates on home equity loans are low now and the interest you’ll pay may be tax-deductible.
