You May Not Know How Much Tax You Owe Till Next Year
Surprisingly, if you own both Deductible and Non-Deductible IRAs and you convert only the Non-Deductible IRA, you won't know how much you owe in taxes until next year. That's because the IRS considers conversions to consist proportionately of each type of IRA you own. For example, if you have $100,000 in IRAs — $40,000 in after-tax contributions and $60,000 in pre-tax contributions. To determine how much of the conversion you'd have to pay taxes on, you divide the pre-tax amount in the account by the total ($60,000/$100,000 = .60). Thus, you would have to pay taxes on 60% of any money you convert. So if you decide to convert $40,000, you'd pay taxes on $24,000. At a tax rate of 28%, that's $6,720.
But this calculation is based on the year-end value of your IRAs — including the money you converted — not their value on the day you converted. So if your account increases in value by year-end (or if you rollover a pre-tax 401(k) into an IRA) you might pay more in taxes than you expect.
Please keep reading for the next Roth IRA conversion complication.