Tax question - late year IRA withdrawal and under withholding penalty

[Gumby]

I'm trying to plan out my strategy for withdrawing money from a taxable IRA.

Assume I have no other income for the year and, in late December of 2019, I pull out $100k from my IRA, all of which is taxable. Suppose I then file my tax return before January 15, 2020 and pay the full amount due on that withdrawal. Will I face an under withholding penalty? In other words, do I need to anticipate the withdrawal and pay the three earlier installments of estimated tax over the course of 2019, or does the obligation to pay estimated tax not get triggered until I take the money in December? (In which case it would only be due in January (I think)).

Now for a slight twist. Suppose I have been receiving social security or pension income over the course of 2019 and have been withholding all along from each check. I then make the $100K IRA withdrawal in late December. Does that change the situation?

Thanks in advance for your thoughts.

 

[GrayHare]

You don't need to pay three ealier installments if with your return you file (forget which form) that breaks down your income by quarter, and shows the big income came during the 4th quarter. If you have income from various sources, it's a tedious form to properly complete.

But instead why not withhold from the IRA withdrawal? The withheld amount is considered to have been paid evenly over the year.

 

[rothlev]

I'm trying to plan out my strategy for withdrawing money from a taxable IRA.

Assume I have no other income for the year and, in late December of 2019, I pull out $100k from my IRA, all of which is taxable. Suppose I then file my tax return before January 15, 2020 and pay the full amount due on that withdrawal. Will I face an under withholding penalty? In other words, do I need to anticipate the withdrawal and pay the three earlier installments of estimated tax over the course of 2019, or does the obligation to pay estimated tax not get triggered until I take the money in December? (In which case it would only be due in January (I think)).

Now for a slight twist. Suppose I have been receiving social security or pension income over the course of 2019 and have been withholding all along from each check. I then make the $100K IRA withdrawal in late December. Does that change the situation?

Thanks in advance for your thoughts.

taxes are pay as you go. Have withholding done on the withdrawal at your estimated tax rate. Try not to have a balance due at the time of filing of more than $1000. use a tax estimator to figure out the amount of taxes to have withheld. There is a 90% of tax due or 100% of last years liability safe harbor.

https://wallethacks.com/estimated-taxes-due-dates-safe-harbor-rules/

 

[RobbieB]

Yeah, make an estimated withholding on the light side. The penalty if anything will be tiny.

 

[RE2Boys]

You don't need to pay three ealier installments if with your return you file (forget which form) that breaks down your income by quarter, and shows the big income came during the 4th quarter. If you have income from various sources, it's a tedious form to properly complete.

But instead why not withhold from the IRA withdrawal? The withheld amount is considered to have been paid evenly over the year.

Form 2210AL

 

[OldShooter]

Tax withholding is considered to have been paid during the year, so we never make quarterly payments. We just have necessary federal and state taxes withheld from an IRA withdrawal in December. We also never worry about estimating taxes due. Our December withdrawal is for the "safe harbor" amount based on our prior year taxes.

So we wouldn't have any worries or calculations for any scenario you might foresee. The keys are (1) we are paying by withholding and (2) we are paying the safe harbor amount.

If this results in overpayment, the float on that until we get the refund is just our cost of convenience. Three months, maybe.

 

[SevenUp]

If one is simply withdrawing from the tIRA, withholding works fine.

If one is converting from traditional to Roth, it's better to convert the full amount and pay tax from other (pension, SS, etc.) withholding or use an estimated payment.

 

[Gumby]

If one is simply withdrawing from the tIRA, withholding works fine.

If one is converting from traditional to Roth, it's better to convert the full amount and pay tax from other (pension, SS, etc.) withholding or use an estimated payment.

Thanks. That more closely fits my actual plan, which is to Roth convert up to the top of the 22% bracket. I guess I'll just have to ramp up the withholding on Social Security and pensions in advance of the withdrawal.

 

[kaneohe]

If the 100K TIRA w/d represents an unusual increase in income over last yr,
check out the safe harbor for prior yr.......you need to have w/h at least 100% of last yr taxes owed for whole yr (110% if AGI > 150K). It's possible you will have met safe harbor or come close even w/o the extra w/h.

 

[kaneohe]

............................

Assume I have no other income for the year and, in late December of 2019, I pull out $100k from my IRA, all of which is taxable. Suppose I then file my tax return before January 15, 2020 and pay the full amount due on that withdrawal. Will I face an under withholding penalty? In other words, do I need to anticipate the withdrawal and pay the three earlier installments of estimated tax over the course of 2019, or does the obligation to pay estimated tax not get triggered until I take the money in December? (In which case it would only be due in January (I think)).

..................................
Thanks in advance for your thoughts.

In this case, IRS doesn't know timing of income so it will expect equal quarterly est. taxes (or equiv. w/h where timing is not important). However in this simplified case w/ income only in Q4, F2210 Sch AI would be extremely easy to fill out to demonstrate that income timing matched tax payment.

 

[cathy63]

...Suppose I then file my tax return before January 15, 2020...

I know your question has been answered, but I wanted to point out that this part of your plan was not actually possible. The IRS doesn't accept tax returns for the prior year that early. This year the "opening date" for tax season was January 28, and some forms weren't available until several weeks later.

 

[CRLLS]

If one is simply withdrawing from the tIRA, withholding works fine.

If one is converting from traditional to Roth, it's better to convert the full amount and pay tax from other (pension, SS, etc.) withholding or use an estimated payment.

And why is it "better" as a rule? If one is trying to reduce IRA balance to minimize future RMDs, it may not be "better". I prefer to be holistic about financial moves as best I can. Looking at only one aspect without considering the whole can easily lead to a less than optimal result. Just sayin'

 

[pb4uski]

I think it depends on whether the objective is to reduce the tax-deferred account or to maximize the Roth.

For discussion purposes, let's say that the tax is a flat 15% to make things simple.

If the OP has $100k of headroom in the 22% bracket, then he could do two transactions.... one a $87k Roth conversion and then a $13k tIRA withdrawal with 100% withholding... this would result in $100k of income and the tax would be covered... but only $87k ends up in the Roth.

Alternatively, the OP could do a $100k Roth conversion and then pay $15K in estimated tax and file a Form 2210AI to avoid any underpayment penalties and interest.

 

[SevenUp]

And why is it "better" as a rule? If one is trying to reduce IRA balance to minimize future RMDs, it may not be "better". I prefer to be holistic about financial moves as best I can. Looking at only one aspect without considering the whole can easily lead to a less than optimal result. Just sayin'

It's better because having more in Roth beats having more in taxable (unless you want to assume investment losses).

 

[Souschef]

I think that it is not a big deal. I made quarterly payments, but owed about $4400 . The penalty was $9, which was not worth my time to fill out a 2210.

 

[RobbieB]

Yup, don't worry about the penalty. Unless you're one of those "dryer sheet" people -

 

[Gumby]

I think it depends on whether the objective is to reduce the tax-deferred account or to maximize the Roth.

For discussion purposes, let's say that the tax is a flat 15% to make things simple.

If the OP has $100k of headroom in the 22% bracket, then he could do two transactions.... one a $87k Roth conversion and then a $13k tIRA withdrawal with 100% withholding... this would result in $100k of income and the tax would be covered... but only $87k ends up in the Roth.

This is a very interesting approach. Thanks.

 

[gerntz]

taxes are pay as you go. Have withholding done on the withdrawal at your estimated tax rate. Try not to have a balance due at the time of filing of more than $1000. use a tax estimator to figure out the amount of taxes to have withheld. There is a 90% of tax due or 100% of last years liability safe harbor.

https://wallethacks.com/estimated-taxes-due-dates-safe-harbor-rules/

+1, though I though the safe harbor was 110% of last year's taxes.

 

[SevenUp]

+1, though I though the safe harbor was 110% of last year's taxes.

It is 110% if last year's AGI was $150K or more, otherwise it's 100%.

 

[Alan]

Thanks. That more closely fits my actual plan, which is to Roth convert up to the top of the 22% bracket. I guess I'll just have to ramp up the withholding on Social Security and pensions in advance of the withdrawal.

I’ve been doing exactly this for the past 3 years. Run the numbers in December to see how much to convert in 1 lump sum. I avoid any penalties by doing quarterly payments up to the safe harbor set on my last return.

 

[CRLLS]

I think it depends on whether the objective is to reduce the tax-deferred account or to maximize the Roth.

For discussion purposes, let's say that the tax is a flat 15% to make things simple.

If the OP has $100k of headroom in the 22% bracket, then he could do two transactions.... one a $87k Roth conversion and then a $13k tIRA withdrawal with 100% withholding... this would result in $100k of income and the tax would be covered... but only $87k ends up in the Roth.

Alternatively, the OP could do a $100k Roth conversion and then pay $15K in estimated tax and file a Form 2210AI to avoid any underpayment penalties and interest.

Exactly, pb4uski.

Making tax payments from taxable account is better as SevenUp has stated, to maximize the Roth. This is a common practice as one is in the building stage of IRA's. However there are other objectives of Roth conversions, and other financial techniques, where it is decidedly not "better". My point was that a single statement of "better" without stating the goal could be taken as an always better.

 

[kaneohe]

Exactly, pb4uski.

Making tax payments from taxable account is better as SevenUp has stated, to maximize the Roth. This is a common practice as one is in the building stage of IRA's. However there are other objectives of Roth conversions, and other financial techniques, where it is decidedly not "better". My point was that a single statement of "better" without stating the goal could be taken as an always better.

Wondering, assuming you did have taxable funds to pay for the conversion taxes, when would it be better not to convert all of the withdrawal from TIRA?

 

[CRLLS]

Assuming that one had a significant amount of cash or cash equivalents to pay the taxes, have enough to do so over then next "n" years worth of conversions, and if they are using the cash bucket strategy, do not dip into that bucket to pay the taxes. Those are a fair amount of if's to consider beyond a simple statement of "better" IMO.

Not everyone is in that camp. I am not. I have read on this site that others are similarly situated. Most of our retirement savings are in IRAs or 401K's. Personally, I am currently trying to maximize my IRA withdrawals to minimize eventual RMDs. These RMDs will push me into the next tax bracket. The more I can get out now while keeping in my current tax bracket, the lower those taxes will be. Possibly keeping me free from increased Medicare premiums (IRRMA).

I hope this makes sense to you.

 

[pb4uski]

Wondering, assuming you did have taxable funds to pay for the conversion taxes, when would it be better not to convert all of the withdrawal from TIRA?

If the objective is to maximize the Roth, then yes.

 

[Lawrencewendall]

I think it depends on whether the objective is to reduce the tax-deferred account or to maximize the Roth.

For discussion purposes, let's say that the tax is a flat 15% to make things simple.

If the OP has $100k of headroom in the 22% bracket, then he could do two transactions.... one a $87k Roth conversion and then a $13k tIRA withdrawal with 100% withholding... this would result in $100k of income and the tax would be covered... but only $87k ends up in the Roth.

Alternatively, the OP could do a $100k Roth conversion and then pay $15K in estimated tax and file a Form 2210AI to avoid any underpayment penalties and interest.

My situation may be a little different and I may have understood FIDO rep incorrectly but since I am under 59.5, if I use the withdrawal to pay taxes, I am subject to the 10% penalty on the taxes paid. I need to pay taxes with cash on hand. Is this correct?