Roth Conversion Mechanics

[almost_there]

I have been following the "Roth Conversions make sense?" thread with some interest. It has me asking some questions but I don't want to hijack that thread so I thought I would ask the questions in a new thread. Note I am > 59.5 and will be retiring the end of this year. Most of my assets are in a traditional IRA and a 401k. I do have a small ROTH IRA already. I have never done anything with these accounts except put money in. I realize that I am somewhat clueless about what happens when you take the money out prior to the RMDs starting.

Here goes:

1. A ROTH conversion seems to be when you take money out of the tIRA/401k and pay the taxes on it with already taxed money from some other source. If you pay the taxes via withholding from the tIRA/401k distribution can you still not put some or all of the proceeds into a ROTH IRA? Is the payment of the taxes from "after tax" money what makes it a conversion?

2. I always assumed that when I start withdrawing from my Vanguard tIRA of Fidelity 401k they will withhold for taxes. Is that the case? Can I ask them to not withhold? It would see that would be a requirement if you are going to pay the taxes from a different source. If they have to withhold how do they figure out the amount? Can I tell them or do they use some tax rules?

Thank You

 

[RunningBum]

My mechanics are that I do a transfer of money from my VG tIRA to my VG Roth. This brings up a page or popup that informs me this is a Roth conversion, a taxable event, and I believe it asks me if I want to withhold taxes on the transaction. I always answer no, because I want the full amount to be converted.

I settle the taxes just as I do for dividends, interest and capital gains. I make quarterly estimated payments. Others have different methods, but the point is it's just more taxable income to deal with.

What makes it a conversion is moving the money from the tIRA to a Roth. How you pay the taxes is just a side issue.

 

[NW-Bound]

1) If you move $10K from your IRA, the $10K will count as income and you owe tax on it, whether you put in in a Roth or "blow the dough".

Let's say the tax is $1K. You can have that $1K withheld, and only move the remaining $9K into the Roth account. Or you can move the entire $10K and pay the $1K tax later from your banking account.



2) When I withdraw from an IRA, my brokers allow me to select to withhold tax or not. If I select "Yes", then they let me choose between the default 10% or something else I type in. So, it is entirely up to me. The brokers do not care. It's me who is responsible to submit the correct amount to the IRS, if not now, then later when I file my tax return.

I always select 10%, because if I wait until the end of the year at the tax return time, I may be levied a penalty for underpayment.

PS. One way to avoid tax underpayment penalty is to do quarterly tax payment, like RunningBum said earlier. I am just too lazy to do this, hence select the 10% withholding.

 

[NW-Bound]

By the way, I also let the broker withhold some money for state tax. I usually select state tax as 20% of fed tax.

That means when I withdraw $10K from my IRA, I only get $8,800 cash transferred to my checking account. One thousand dollars go to the IRS, and $200 goes to my state.

It's never the right amount, and I either get some money back or have to pay more at the year end. But so far, I have not been hit with any penalty. YMMV.

 

[pb4uski]

I have been following the "Roth Conversions make sense?" thread with some interest. It has me asking some questions but I don't want to hijack that thread so I thought I would ask the questions in a new thread. Note I am > 59.5 and will be retiring the end of this year. Most of my assets are in a traditional IRA and a 401k. I do have a small ROTH IRA already. I have never done anything with these accounts except put money in. I realize that I am somewhat clueless about what happens when you take the money out prior to the RMDs starting.

Here goes:

1. A ROTH conversion seems to be when you take money out of the tIRA/401k and pay the taxes on it with already taxed money from some other source. If you pay the taxes via withholding from the tIRA/401k distribution can you still not put some or all of the proceeds into a ROTH IRA? Is the payment of the taxes from "after tax" money what makes it a conversion?

2. I always assumed that when I start withdrawing from my Vanguard tIRA of Fidelity 401k they will withhold for taxes. Is that the case? Can I ask them to not withhold? It would see that would be a requirement if you are going to pay the taxes from a different source. If they have to withhold how do they figure out the amount? Can I tell them or do they use some tax rules?

Thank You

1. You don't have to pay the taxes with after-tax money to have a conversion, but paying the tax with after-tax money is the preferable way to do a conversion.

Example 1, you take $10k out of your IRA, have 15% withheld so $8.5k ends up in the Roth... you have a $8.5k conversion and a $1.5k withdrawal (that is sent on to the IRS as an estimatd tax payment rather than to you)... and $10k of income (the amount withdrawn from the tIRA).

Example 2, you have $10k taken out of your IRA and moved to your Roth... you still have $10k of income but since you are paying the tax with after-tax money you end up with more in your Roth. Example 2 is the preferable way to do it.. it is like being able to contribute to a Roth even if you don't have earned income.

2. Vanguard gives you a plethora of options with respect to withholding.. see below.

 

[Animorph]

Roth conversions may be made without withholding any taxes. However, you will still owe whatever taxes are due and will need to withhold them from some other income or pay estimated taxes in four equal payments. That's what we do. The benefit of paying the taxes from a taxable source is that it allows you to put your full conversion amount into the Roth instead of just what's left after taxes. That's more in your retirement accounts and less in your taxable accounts, which should be a good thing.

 

[kaneohe]

How to Bypass Mandatory Withholding on a 401(k) Distribution | FiGuide

20% w/h mandatory on 401K withdrawals to you. No mandatory w/h on a direct 401K transfer to IRA. No mandatory w/h on 401K RMDs .

No mandatory w/h on IRA withdrawals.

 

[downrod]

I'm following this thread also. I have a question. If I do a direct conversion from a traditional IRA to a Roth IRA, I understand paying the taxes, but does the amount that I convert count as income, potentially raising my tax bracket? That doesnt make sense to me. I am thinking that since it is IRA to IRA, and none of it actually comes to me, that it would not be counted as income, but I could certainly be wrong

 

[copyright1997reloaded]

I'm following this thread also. I have a question. If I do a direct conversion from a traditional IRA to a Roth IRA, I understand paying the taxes, but does the amount that I convert count as income, potentially raising my tax bracket? That doesnt make sense to me. I am thinking that since it is IRA to IRA, and none of it actually comes to me, that it would not be counted as income, but I could certainly be wrong

Yes, it counts as income, and can bump you to a higher bracket...and can mess with tax-ability of social security income, and mess with your medicare payment, and mess with your FASFA calcs, and so on. ETA: Because of these other factors (depending on your situation), the marginal tax rate can be MUCH higher.

Here's a good article w/examples: https://www.kitces.com/blog/long-term-capital-gains-bump-zone-higher-marginal-tax-rate-phase-in-0-rate/

 

[Clone]

Here is how I have done ROTH conversions:

1: Roth convert from tIRA to ROTH
2: Take withdrawal from inherited IRA (which can not be converted) and send 90% to Fed and 10% to State taxes. This withdrawal will count towards the RMD amount.

You could pull the taxes from a 401k or tIRA as well. I prefer to do this rather than send in quarterly estimates, but will probably need to start doing estimates soon. If our financial cashflows ever stabilize.

 

[RunningBum]

I'm following this thread also. I have a question. If I do a direct conversion from a traditional IRA to a Roth IRA, I understand paying the taxes, but does the amount that I convert count as income, potentially raising my tax bracket? That doesnt make sense to me. I am thinking that since it is IRA to IRA, and none of it actually comes to me, that it would not be counted as income, but I could certainly be wrong

Not sure how you can understand paying the taxes, but don't think it should be income? Taxes are paid on income. Period. There are various forms on income, and this is one of them.

Anyway, the reason is that the conversion is to a totally different type of IRA. You'll never be hit with taxes on Roth withdrawals, so the only chance they have to collect the taxes from when you put it in the tIRA (deferred income) is at conversion time.

As far as raising the tax bracket, yes, but only the portion in that bracket is taxed at that rate, not all of your income. Just making sure you're not one that thinks that if you hit the 22% bracket, for example, all of your income is taxed at 22%. Some is at 12%, some 10%, and the part canceled out by your deduction is 0%.

 

[Cobra9777]

Roth Mechanics

My conversion is an in-kind transfer of shares from the tIRA to the Roth account. No withholding. I pay tax via quarterly estimated payments.

It's definitely preferable to pay conversion tax from a separate taxable account. In effect, it's like a transfer from taxable to the Roth. So in the future when it's withdrawn, it escapes whatever tax might have been incurred if it had been withdrawn from the taxable account.

I'm converting to the top of the 12% bracket. So I usually do the conversion late in December after the rest of my return is firmed up. I sometimes have to use the annualized income method to avoid a small penalty for underwithholding.

 

[ocean view]

I'm following this thread also. I have a question. If I do a direct conversion from a traditional IRA to a Roth IRA, I understand paying the taxes, but does the amount that I convert count as income, potentially raising my tax bracket? That doesnt make sense to me. I am thinking that since it is IRA to IRA, and none of it actually comes to me, that it would not be counted as income, but I could certainly be wrong

I think you are unclear on the basic fundamental difference between the two types of IRA accounts.

A tIRA is funded with tax deferred contributions, so whenever you make a withdrawal, that withdrawal becomes taxable income. A Roth IRA is funded with post-tax money, so all future withdrawals are tax free.

 

[downrod]

I think you are unclear on the basic fundamental difference between the two types of IRA accounts.

A tIRA is funded with tax deferred contributions, so whenever you make a withdrawal, that withdrawal becomes taxable income. A Roth IRA is funded with post-tax money, so all future withdrawals are tax free.

I understand the difference between the two types of accounts. So what I am gathering from this is that a conversion to a Roth IRA is treated exactly like a distribution from a tIRA, for tax purposes. I understand now. I had thought that since it was a transfer from one type of IRA to another, that the amount converted would not count as income. Based upon the replies, I see that is not the case

 

[pb4uski]

^^^ You got it.... for the tIRA the same as a withdrawal... in both cases amount withdrawn is taxable as pension income.

 

[Squirrel]

I have never done a Roth conversion, so this might be a basic question for many of you:

How much extra tax paperwork is required when you convert from tIRA to Roth?

 

[pb4uski]

No extra tax paperwork.

You will receive from 1099-R from the brokerage that holds the tIRA a 1099-R for the income for any withdrwals (including the conversion) and you report the amount as pension income on your tax return.

In fact, if you use TT, you simply the amount is included when you import tax information from your broker.... all you have to do is give it a lookover to see if they amount is correct.

 

[Squirrel]

You will receive from 1099-R from the brokerage that holds the tIRA a 1099-R for the income for any withdrwals (including the conversion) and you report the amount as pension income on your tax return.

Good info. Now, when we see how close we are to the next tax bracket, I'll consider a conversion.

 

[RunningBum]

Well, yes, there is extra paper work when you prepare your return, but TT should handle the 1099-R. In the interview there are a few questions to answer, about 4 screens I think. Make sure you check that you moved the funds to another investment account, and that you converted the money to a Roth IRA.

Form 8606 is added to your return. Unless you have complications that make you fill out part I for non-deductible contributions to your IRA, it's just a matter of 3 lines in part II, the first and last of which are you conversion amount.

This amount also shows up on 1040 lines 7a and 7b.

If you were asking how much tax paper work you do when you actually do the conversion, none.

It's all real easy. IMO this should not be a reason to not convert, even if you do taxes all on your own.

 

[targatom2019]

not mean to highjack this thread but if a person is 50 yo with 1 mill in Tira but does not need the $$ for another 11 years then would you recommend to do a smaller conversation to Roth the next 11 years ? Besides paying taxes will there be a penalty to do a conversion at 50 yo ?

 

[RunningBum]

No penalty on conversion.

As has been said many times on various threads, the advantage to a Roth conversion is if your tax rate now is lower (or the same) as you expect it will be in the future, factoring in RMDs if you don't convert. You don't give that kind of information for your case so it's impossible for any of us to answer.

Also, don't threadjack. Start your own thread. Your question is different than this thread topic.

 

[zinger1457]

not mean to highjack this thread but if a person is 50 yo with 1 mill in Tira but does not need the $$ for another 11 years then would you recommend to do a smaller conversation to Roth the next 11 years ? Besides paying taxes will there be a penalty to do a conversion at 50 yo ?

No penalty for doing a conversion at 50. Whether in makes sense to start converting now depends on current and expected future tax brackets. Suggest you use one of the online calculators. Here's one from Schwab:


https://www.schwab.com/public/schwa...ding_iras/ira_calculators/roth_ira_conversion

 

[pb4uski]

Yes, absolutely do conversions as long as you can do them at a lower tax rate than once SS and other retirement income streams start.

No penalty on conversions.

 

[SecondCor521]

I have never done a Roth conversion, so this might be a basic question for many of you:

How much extra tax paperwork is required when you convert from tIRA to Roth?

If you're doing conversions before age 59.5 and may use a Roth conversion ladder to withdraw converted amounts before age 59.5, you'll want to keep track of the net conversion amounts so you don't pay taxes or penalties on those withdrawals.

This can be done by retaining copies of your Form 8606's from the years in which you do the conversions.

ETA: Withdrawals are deemed (by the IRS) to be from contributions first then conversions, oldest to newest. So if you do this, you'll also want to keep track of your Roth contributions by retaining Form 5498's and/or keeping records from your IRA custodian.

 

[RunningBum]

If you're doing conversions before age 59.5 and may use a Roth conversion ladder to withdraw converted amounts before age 59.5, you'll want to keep track of the net conversion amounts so you don't pay taxes or penalties on those withdrawals.

This can be done by retaining copies of your Form 8606's from the years in which you do the conversions.

ETA: Withdrawals are deemed (by the IRS) to be from contributions first then conversions, oldest to newest. So if you do this, you'll also want to keep track of your Roth contributions by retaining Form 5498's and/or keeping records from your IRA custodian.

Funny story tonight.

I have a spreadsheet to keep track of exactly this. All my contributions and conversions and when I can access them if needed. I actually forgot I had it until now, and hadn't updated it in 2 years. So I added my 2017 and 2018 conversions, and browsed my history out of curiosity. Hmm, a contribution in 2012? But I retired in 2011! Uh-oh. That's an excess contribution. 6% penalty per year, plus interest. That's $360/yr for 7 years, over $2500, plus interest. I go back and check my VG transaction history online to see if I really made that contribution. I did. Crap. I start googling...maybe you won't get caught, but there's no statute of limitations so the penalty and interest keep adding up. How do I back it out now? Advice seems to be to call the VG IRA dept.

I go get my 2012 tax folder which includes all the end of year stuff VG sent. Yep, there it is again. But wait, here's some other form. A recharacterization of that $6000 a few weeks later, and my handwritten note explaining it. Whew! Apparently I caught it, and quickly backed it out, and even reported the tax on the small amount I made in those 3 weeks. I look at my VG transactions and see where I backed it out there.

That was a nasty hour while I thought I had screwed up. I updated my spreadsheet to zero out that contribution and make a note of the backout recharacterization, so I won't go through this again even if I somehow find that contribution again.

Some people say not to bother saving old tax records beyond 3 years or 5 years. Glad I didn't listen to that!