Roth Conversion

B is correct. The Roth conversion strategy is appropriate for David because he expects to be in a higher tax bracket in retirement (32%) than he is currently (24%). By converting $80,000 now and paying $19,200 in taxes (24% rate), he avoids paying 32% tax on the same amount (plus growth) in retirement. The 8-percentage-point tax savings (32% - 24%) on both the principal and decades of future growth makes this conversion financially beneficial. Additionally, the converted Roth IRA will have no RMDs during his lifetime, giving him more control over retirement distributions.

A is incorrect because retirement withdrawals from Traditional IRAs are NOT tax-free; they are taxed as ordinary income. David will not "avoid all taxes" by waiting; he will pay higher taxes (32%) on larger amounts (original balance plus growth). The question is not whether to pay taxes, but when and at what rate. B is incorrect about avoiding all taxes. C is completely false: there is no age restriction on Roth conversions. Anyone can convert at any age. D is false: there are no dollar limits on Roth conversions. You can convert any amount, regardless of account balance (though large conversions may push you into higher tax brackets).

B is correct. Roth conversions are taxed as ordinary income in the year of conversion, at the taxpayer's marginal tax rate. The entire pre-tax amount converted is added to taxable income for that year. For example, converting $50,000 while in the 24% bracket adds $12,000 in federal income tax liability.

A is incorrect because conversions are not treated as capital gains; they are ordinary income regardless of what assets are held in the IRA. C is incorrect because there is no flat 10% conversion tax. The 10% early withdrawal penalty does NOT apply to the conversion itself (only to early withdrawals of converted amounts within 5 years if under 59½). D is incorrect because taxes are due immediately in the year of conversion, not deferred until later Roth IRA withdrawals. In fact, qualified Roth distributions are tax-free, so if taxes were not paid at conversion, they would never be paid.

B is correct. Calculate the total tax liability:

Federal tax: $100,000 × 32% = $32,000
State tax: $100,000 × 5% = $5,000
Total tax liability: $32,000 + $5,000 = $37,000

The conversion adds $100,000 to taxable income, which is taxed at both federal (32%) and state (5%) marginal rates. Combined effective rate is 37%.

A ($32,000) only includes federal tax and omits the $5,000 state tax liability. C ($42,000) incorrectly adds a 10% penalty, but the 10% early withdrawal penalty does NOT apply to conversions themselves (only to early withdrawals of converted amounts). D ($47,000) incorrectly combines federal, state, and a non-existent penalty.

C is correct (the EXCEPT answer). Roth conversions are NO LONGER recharacterizable (reversible). The Tax Cuts and Jobs Act of 2017 eliminated the ability to recharacterize conversions starting in 2018. Once you convert to a Roth IRA, the conversion is permanent and irrevocable. This is a critical change from pre-2018 rules when taxpayers could reverse conversions until the tax filing deadline (including extensions).

A is accurate: Since 2010, income limits for Roth conversions were eliminated. High earners who exceed the Roth IRA contribution income limits can still convert unlimited amounts from Traditional IRAs to Roth IRAs (the "backdoor Roth" strategy). B is accurate: Each conversion has its own 5-year clock starting January 1 of the conversion year. If you convert amounts in 2024, 2025, and 2026, each conversion has a separate 5-year holding period for penalty-free access. D is accurate: Conversions trigger ordinary income tax in the conversion year on the pre-tax amount converted, taxed at marginal rates.

A is correct. Only statements 2 and 4 are accurate.

Statement 1 is FALSE: There are NO income limits for Roth conversions. The income limits ($242,000-$252,000 MAGI for married filing jointly in 2026) apply only to direct Roth IRA contributions, not conversions. Since 2010, anyone can convert regardless of income level. This is precisely why high earners use the "backdoor Roth" strategy: contribute to a non-deductible Traditional IRA, then immediately convert to Roth IRA, bypassing contribution income limits.

Statement 2 is TRUE: The $150,000 conversion adds to her taxable income and is taxed at her 35% marginal rate: $150,000 × 35% = $52,500 in federal tax (plus state taxes if applicable). This tax is due in the year of conversion (2026).

Statement 3 is FALSE: The 10% early withdrawal penalty would NOT apply to this scenario. While each conversion is subject to a 5-year holding period, the penalty only applies if TWO conditions are met: (1) withdrawal before the 5-year period, AND (2) the owner is under age 59½. Here, she converts in 2026 and withdraws in 2029 (only 3 years, violating the 5-year rule), BUT she is age 65 at withdrawal (over 59½), so the age exception applies and no penalty is owed. The 5-year rule for conversions only matters if you are under 59½.

Statement 4 is TRUE: Roth IRAs have no required minimum distributions during the owner's lifetime. After conversion, the funds will grow tax-free and never be subject to RMDs while she is alive, unlike her Traditional IRA which would require RMDs starting at age 73.