EDITOR'S NOTE: This article was originally published in the June 2010 issue of Kiplinger's Retirement Report. To subscribe, click here.
When you are considering a Roth conversion, the federal tax bite is not your only concern. If you live in a state that taxes retirement income, your state will probably pile on with a tax bill, too. On the bright side, if you're in a state that gives retirement income a break -- or doesn't tax income at all -- you'll get a break on the conversion.
The key is to know how your state tax authority treats a Roth conversion before you make your decision. Residents of Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming can convert without state tax because those states don't tax income. New Hampshire and Tennessee collect tax on interest and dividends, but don't tax IRA distributions, so residents can convert without state tax consequences.
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Many states that have a personal income tax offer exemptions for retirement income. In Pennsylvania, where contributions to a retirement account are not tax-deductible, a retiree over age 59 1/2 can make tax-free withdrawals from a 401(k) or IRA. Account owners can do a Roth conversion without any state tax consequence, including no state tax owed on earnings, says Stephen Bleyer, a certified public accountant in the Bala Cynwyd, Pa., office of Marcum, an accounting firm.
Meanwhile, some states offer partial exclusions of retirement income. In Iowa, taxpayers 55 and older can exclude up to $6,000 of retirement income ($12,000 for married taxpayers). The Iowa Department of Revenue says Roth conversion income is eligible for that exclusion. Special breaks for retirement income, such as Iowa's, are often based on age or income.
If your state taxes retirement income, prepare to add the bill to your federal tab. Virginia, for example, has a top income-tax rate of 5.75%. If you convert $200,000, you'd owe nearly $11,300 in state tax -- on top of what you owe Uncle Sam. (All states follow the federal rule, which allows taxpayers to report a 2010 conversion over the following two tax years.)
Before converting, check with your state tax department. If you plan to retire in a different state, check that state's tax law. Depending on how that state stacks up to your current state, you might want to accelerate a Roth conversion or hold off.
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