When considering converting a traditional IRA to a Roth IRA, it is important for residents of states with income taxes to review how the transaction will be treated by their state. Under federal tax law, the amount rolled over from a traditional IRA to a Roth IRA will be included in gross income, but will not be taxed by the state. This means that the amount rolled over will be taxed as though it were distributed, but will remain in the Roth IRA to compound tax-free.
Most states treat IRA conversions in a similar manner, but there are differences and nuances that residents should be aware of. States without income taxes do not tax IRA conversions, while some states have specific rules and exclusions. For example, New Hampshire does not tax IRA distributions, making conversions tax-free for its residents. Pennsylvania and Iowa also have rules that allow for tax-free IRA conversions, while states like Massachusetts and California impose additional taxes on high income earners.
Residents of states with high taxes or threshold limits need to carefully consider how an IRA conversion could impact their tax bill. In some states, additional income from an IRA conversion could push taxpayers into a higher tax bracket, resulting in higher tax payments. It is important to know where you stand in the state tax brackets and how much can be converted before reaching a higher tax bracket.
Some states have unique laws regarding retirement income and deductions that can impact how IRA conversions are taxed. For example, in New Jersey, taxpayers age 62 or older can exclude pension income, including IRA distributions, up to a certain income limit. Residents of states with laws similar to New Jersey’s may need to limit the amount of an IRA conversion to avoid losing these exclusions and facing higher taxes.
While federal income taxes should be the primary consideration when deciding whether to convert a traditional IRA to a Roth IRA, state taxes can also play a significant role. Residents should thoroughly examine their state’s tax laws and understand how an IRA conversion would affect their tax bill. By taking advantage of state deductions and exclusions, taxpayers can minimize their tax liability and make informed decisions about IRA conversions.
