Adoption Tax Credit on a Roth IRA conversion

Question

I have over a $12K adoption tax credit I'm trying to burn up. Last year, I converted most of my retirement from a traditional to a Roth IRA. We have 2 kids, and I thought I would get $2K for the child tax credit ($1K per child). However, after I filled out everything, I only got about $400 back. I was shocked to find out that converting from a traditional to a Roth used my child tax credit FIRST, then used my adoption tax credit. Can someone explain this? I'm thinking about converting the rest of my retirement to a Roth, but if it takes away our child tax credit, then it doesn't seem worth it. Thanks in advance for your answers.

Answer 1

When you convert a Traditional IRA to a Roth you pay income tax on the conversion amount.  There's no way to avoid that.  You don't pay the 10% penalty but taxes are due.

Credits of any type reduce your tax dollar for dollar.  The sequence that they are applied is based upon the law.  Most credits are non-refundable meaning that they only reduce your tax liability to $0.  Any unused credit at that point is lost.  If you are taking a tax hit on the conversion then the credits are doing their job, i.e. reducing your tax liability.  Look at the bright side here, at least you're not having to write a check as some folks do.

Over time a Roth will always work out better for you unless you are very close to retirement age.  That's because with a Roth the money is taxed going in but all gains are TAX FREE on the other end.  With a Traditional IRA you do get some tax benefit now but the gains are taxable as ordinary income when you withdraw them.

Answer 2

Your money in Trad IRA was tax deferred money that is you did not pay income tax on that money. When  you withdraw from Trad IRA, all the withdrawal adds to your taxable income. You must pay income tax on that money.

Money you invest in Roth IRA is after tax money that is money on which you have already paid income tax. Now when you withdraw from Roth IRA, it will not be taxable income.

Read about Trad IRA and Roth IRA http://taxipay.blogspot.com/2008/05/trad...