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Taxes on IRA Withdrawals and Conversions
Old 12-02-2012, 01:48 PM   #1
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Taxes on IRA Withdrawals and Conversions

I am thinking of rolling over my 401K into an IRA. From the IRA, I want to make withdrawals to cover expenses and also convert some funds into a Roth IRA.

How are taxes handled when:
1. You make the withdrawal.
2. You do a Roth IRA conversion.
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Old 12-02-2012, 01:52 PM   #2
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For both you will receive a Form 1099-R representing the IRA withdrawal. For tax purposes the withdrawal amount is considered ordinary income. If you had made non-deductable contributions to your tIRA, those dollars will not be taxed but any earnings on them will (again as ordinary income).
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Old 12-02-2012, 02:42 PM   #3
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How are the taxes paid? Are they taken out of the withdrawals? So, if I want to need 10K, do I request a 10K withdrawal and get the 10K - which means I have to get the taxes from other sources. Or, are the taxes taken out of the 10K?
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Old 12-02-2012, 02:48 PM   #4
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Taxes can come from either your checking account or be withheld or from your paycheck. You get to decide.

For a conversion, it is best to pay taxes from non-IRA sources such as a taxable account or paycheck. That leaves the most money going to conversion and the least amount of taxes.
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Old 12-02-2012, 02:48 PM   #5
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When I take a withdrawal from my IRA, I have the option of having taxes withdrawn from the funds. I can specifcy the % I want withheld. This is what I usually do. So if I need $10K and want 20% withheld, I request $12,500.

If I wanted to convert $10K to an IRA and pay the taxes from another source, I'd either plan to pay when I file or I'd send in the taxes with the estimated fomr (1040-ES).

Otherwise, the taxes are owed when you file. You do want to be careful that you don't incur a penalty for underwithholding.
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Old 12-02-2012, 02:50 PM   #6
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How are the taxes paid? Are they taken out of the withdrawals? So, if I want to need 10K, do I request a 10K withdrawal and get the 10K - which means I have to get the taxes from other sources. Or, are the taxes taken out of the 10K?
When I make my withdrawals my brokerage custodian asks if I want taxes withheld. I usually decline and make quarterly payments.
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Old 12-02-2012, 02:51 PM   #7
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How are the taxes paid? Are they taken out of the withdrawals? So, if I want to need 10K, do I request a 10K withdrawal and get the 10K - which means I have to get the taxes from other sources. Or, are the taxes taken out of the 10K?
You can choose to have taxes withheld when you make the withdrawals. Those withholding's will show on your 1099-Rs.
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Old 12-02-2012, 02:51 PM   #8
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On withdrawals the default is to not withhold taxes, but I believe some IRA custodians will send a 10% withholding to the IRS if you tell them to. With your 1040 filing you'll still need to pay any shortfall. For a Roth conversion you don't actually receive any money in hand, so you need to pay the tax from another source, or withdraw it from the IRA. The latter is typically a poor choice since it reduces your IRA value and may be subject to an early withdrawal penalty.
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Old 12-02-2012, 03:40 PM   #9
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Taxes can come from either your checking account or be withheld or from your paycheck. You get to decide.

For a conversion, it is best to pay taxes from non-IRA sources such as a taxable account or paycheck. That leaves the most money going to conversion and the least amount of taxes.
My plan is to make withdrawals and conversions when I have used my taxable accounts (except for the emergency fund), so the tax money will have to come from the withdrawals. For withdrawals to cover living expenses, I have no choice - I have to do it.

But, for the conversion, I can either forego the conversion or withdraw more funds to cover the taxes. Will there be any advantage of 1 over the other option.

Now, that is the plan when the taxable account run out. But, I still have enough funds to implement your suggestion above. Please explain to me why taking the funds from non-IRA sources will result in the least taxes versus using the IRA money.

Thanks.
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Old 12-02-2012, 04:43 PM   #10
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But, for the conversion, I can either forego the conversion or withdraw more funds to cover the taxes. Will there be any advantage of 1 over the other option.
Most people, myself included, think it is to your advantage to keep as much as possible in tax protected accounts. This says that if you have funds outside of retirement to pay the income tax on the conversion, do it that way.
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Old 12-02-2012, 04:46 PM   #11
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And as someone already said, paying it through quarterly taxes is the common way to handle this. If you convert in January 2012 and don't pay taxes on this until April 2013, the IRS may charge you interest depending on how significant the amount is to the rest of your income. Maybe even an underpayment penalty.
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Old 12-02-2012, 04:53 PM   #12
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Please explain to me why taking the funds from non-IRA sources will result in the least taxes versus using the IRA money.

Since you have already paid taxes on the investment, all that you owe is whatever the investment has grown to less the basis.
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Old 12-02-2012, 07:00 PM   #13
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....
Now, that is the plan when the taxable account run out. But, I still have enough funds to implement your suggestion above. Please explain to me why taking the funds from non-IRA sources will result in the least taxes versus using the IRA money.

Thanks.
There are lots of ideas and explanations in this thread:
Bogleheads • View topic - How to pay ZERO taxes in retirement with 6-figure expenses
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Old 12-02-2012, 07:04 PM   #14
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Thanks all for the information. I have a lot of work on the spreadsheet to do.

OT or is it? There will be some periods when we start RMD that we will be on the (presently) 25% tax bracket. Would it be wise to up my Roth conversion before RMD so that some of the amounts will be on the 25%.
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Old 12-02-2012, 08:33 PM   #15
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All IRA withdrawals are ordinary income.
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Old 12-02-2012, 08:55 PM   #16
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All IRA withdrawals are ordinary income.
...less any pro rated basis.
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Old 12-03-2012, 07:39 AM   #17
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...less any pro rated basis.
Bruce
Correct, which in my case is zero so I tend to forget about that.

I could never see the attraction of non-deductible IRAs - I preferred taxable investments.
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Old 12-03-2012, 09:28 AM   #18
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On withdrawals the default is to not withhold taxes, but I believe some IRA custodians will send a 10% withholding to the IRS if you tell them to. With your 1040 filing you'll still need to pay any shortfall. For a Roth conversion you don't actually receive any money in hand, so you need to pay the tax from another source, or withdraw it from the IRA. The latter is typically a poor choice since it reduces your IRA value and may be subject to an early withdrawal penalty.
I just converted a T-IRA to a Roth and had Vanguard withhold taxes. I asked for 15 % Federal and they did. The scary part was the Michigan witholdoing. I asked to withold a specific amount. When I looked at my balances the next day they were less than expected in the Roth; no explanation at all from Vanguard! When I called I found out the state of Michigan changed my withholding to the exact tax liability, to the penny! I was a bit upset that Vanguard didn't let me know, I found out by checking my balances the next day, so BE CAREFUL!
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Old 12-03-2012, 10:00 AM   #19
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How would Michigan know your "exact tax liability" until you file your return?

I suppose they figure it is easier for them to make a refund to you later than chase you for the taxes.
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Old 12-03-2012, 10:10 AM   #20
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How would Michigan know your "exact tax liability" until you file your return?

I suppose they figure it is easier for them to make a refund to you later than chase you for the taxes.
They multiplied the converted amount by .0435 (the tax is a flat rate on everyone). They must assume that I made enough in other income to reach the max. They also know my pension as it's through their public employee retirement system, as I was an instructor. I should get something back, as the rate is supposed to drop to .0425. YAY!
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