Monday, April 03, 2006

IRA Conversion May Trigger Tax Penalty

If, like me, you're thinking about converting your traditional IRA to a Roth IRA, then you should read money columnist Humberto Cruz's response to a reader's 'question' in this Sunday's edition of the Chicago Tribune.

Here's an excerpt from the article:

A reader reminds me of a potential pitfall of individual retirement account conversions.

Q. I've read a few articles, including yours, about the benefits of converting a traditional IRA to a Roth IRA. I did this last year (converted just enough to stay in the 15 percent tax bracket), but now it seems I'll be paying a penalty because of not making estimated tax payments. None of the articles I've read about IRA conversions mentioned making estimated tax payments to avoid a penalty. This is an important point.

A. If you don't withhold enough or don't have money withheld at must make estimated tax payments four times during the tax year: by April 15, June 15, Sept. 15 and the following Jan. 15. When you convert a traditional IRA to a Roth, the additional taxable income from the conversion may require you to make estimated tax payments. (One exception would be if you have taxes withheld at work and the withholding is already high enough or can be increased to take care of this new tax liability.) Otherwise, failure to make the minimum required estimated payments could trigger a penalty, even if you pay the full amount due by April 15.

The moral of the story is that if you plan to convert a traditional IRA to a Roth, make sure that you either (a) increase your withholdings, or (b) make estimated tax payments. The article goes on to say that "all taxpayers can make free electronic payments at the government's Electronic Federal Tax Payment System Web site ("

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