Unplanned Roth Conversion and Taxes

[Koolau]

I screwed up my tax planning for the year and wondered if the group could help me make up my mind about an unplanned Roth conversion yet this year. I have never done my own taxes and know surprisingly little about the nuances. My bad!

At the beginning of the year, I decided NOT to convert my last Trad. IRA (about $60K now). Based on previous years spending/income, I thought it would cost too much in taxes. BUT, my taxable income will be lower than I planned by about $60K (+/- $20K). So why not convert?

1. Converting has all the usual benefits (and downsides) of Roth conversion - I'm okay with paying the taxes with after tax money.

2. Converting this year would mean I would have ONLY my 401(k) remaining to apply RMDs to next year. (DW has converted ALL IRAs to Roths). (As Forest Gump would say "One less thing.")

3. Breaking into the 25% bracket is a given for the rest of my life, so...

Here is the issue: If I have not paid enough quarterly taxes to cover the conversion, what kind of penalties might I expect? Are they a "nuisance" (a couple of hundred dollars) or draconian (a thousand or more.) Can't find a good source and I know you folks will have an idea.

Thanks for any advice you can offer.

[Alan]

The last payment to the IRS is not due until January, plus you can make estimated payments at anytime so if you make an estimated payment in the same month you convert I would think you may be okay.

I only say this based on somethig a few years back when DW had an unexpected large capital gain from the sale of a house in the UK late in the year so I made an estimated IRS payment in the same time period and we did not have a penalty to pay.

ETA

https://www.irs.gov/publications/p505/ch04.html

Quote:

Penalty figured separately for each period. Because the penalty is figured separately for each payment period, you may owe a penalty for an earlier payment period even if you later paid enough to make up the underpayment. This is true even if you are due a refund when you file your income tax return.

[kaneohe]

The penalty for late est. tax is basically interest on the amount that is date for the time that it is late. I don't know what the current interest rate is but for many yrs now, it's been 3%. If you don't pay the last installment by Jan 15 but pay it by April 15 , then you're paying something like 3% for 3 mos on the late amount.

There are safe harbors .......if you pay 100% (or 110% for higher earners) of
last yrs taxes, you're ok or if you pay 90% of this yrs taxes.

You will have to fill out F2210 Sch AI to demonstrate you had lumpy income and thus paid lumpy est. taxes.

[Koolau]

Thanks for the replies. I was thinking it was a relatively small issue, though tax law is not always "reasonable." I may have a State tax liability as well. I know in times past, they "fine" you (less than $100 IIRC) if you don't make equal payments - even for last minute stuff, though I may be castigating them unfairly.

Thanks again.

[GrayHare]

AFAIK, if you have the brokerage withhold taxes from a Roth conversion done in, say, December, the tax man considers the amount withheld as if it had been spread evenly over the course of the year.

[Koolau]

Quote:

Originally Posted by GrayHare AFAIK, if you have the brokerage withhold taxes from a Roth conversion done in, say, December, the tax man considers the amount withheld as if it had been spread evenly over the course of the year.

Were this a withdrawal, that would work (at least for the Feds). Since it's a conversion, I don't know of any way to "withhold" taxes nor would I want to (I'd rather pay the taxes from other funds and convert the entire amount.) I may call the brokerage and see if they know of a way to send in a payment. I have "cash" with them.

Thanks.

[kaneohe]

Quote:

Originally Posted by GrayHare AFAIK, if you have the brokerage withhold taxes from a Roth conversion done in, say, December, the tax man considers the amount withheld as if it had been spread evenly over the course of the year.

Folks do this in Dec. from TIRA distributions (e.g. RMDs) to get the benefit of late-in-the-yr payments. Not sure it would be an ideal way to do a Roth conversion since it reduces the amount in the Roth and shifts the odds of the Roth conversion being a good deal.

[GrayHare]

Quote:

Originally Posted by kaneohe Folks do this in Dec. from TIRA distributions (e.g. RMDs) to get the benefit of late-in-the-yr payments. Not sure it would be an ideal way to do a Roth conversion since it reduces the amount in the Roth and shifts the odds of the Roth conversion being a good deal.

That's a good point, but why am I remembering a non-taxable process to deposit new funds into the Roth to replace the money lost to withholding? Or does that apply only to a 401k? I've never done this so my thoughts are hazy about it.

[kaneohe]

Quote:

Originally Posted by GrayHare That's a good point, but why am I remembering a non-taxable process to deposit new funds into the Roth to replace the money lost to withholding? Or does that apply only to a 401k? I've never done this so my thoughts are hazy about it.

Interesting idea..........I know I've read about e.g. taking a TIRA withdrawal late in the year.........using withholding of part/all of it to pay the taxes late and still get the benefit of withholding's "being paid evenly throughout the yr" and then replacing the withholding with taxable funds within 60 days into the TIRA.
That was ok until the one rollover /yr came along.

But the Roth conversion possibly may be a different animal since Roth conversions aren't limited by the 1 rollover/yr rule so may be worth some further searching.................

[audreyh1]

You might have have to do annualized income to avoid penalty, but if you can arrange to have enough taxes withheld from your conversion, you might escape form 2210 too.

Oh well - you probably don't want withholding, so all can go to a Roth, never mind.

Anyway, you really have until Jan 15 to resolve estimated taxes - 90% of taxes owed are due by then. Since this "extra taxable income" occurred in the 4th quarter, paying taxes by Jan 15 will mean no penalty, maybe just more paperwork.

[Koolau]

Thanks to all who replied and gave me ideas for my unplanned Roth Conversion.

UPDATE UPDATE UPDATE UPDATE UPDATE UPDATE

I called my tax guy (Bombastic Bushkin - if any of you recall Johnny Carson talking about his tax guy.) He will prepare quarterly forms for me to send in with the calculated amount of tax (state and Fed) triggered by the conversion. I will submit these with the amount estimated by Jan. 15 next year. I suppose it's possible that NOT smoothing out the payment may cost me a (hopefully) small penalty. It will be worth it to no longer own ANY Trad. IRAs. Now DW and I will own ONLY Roth IRAs and ONLY one 401(k) - The latter being the only thing to which RMDs will apply. Admittedly, the 401(k) is pretty good sized, so I will need to carefully manage tax planning from now on (and will, no doubt, have at least some exposure to the 25% bracket - unless, of course, things change in the future.) Good problems to have in the great scheme of things.

At least some weight has now been lifted from my mind as I have applied for SS, converted my last tIRA to Roth and figured (in general terms) how I will pay the estimated taxes. A good week, indeed - and it's partly due to the kind folks on this forum who gave me the confidence to "just do it."

Have a wonderful Holiday Season. Aloha!

[gauss]

Penalties and Interest on late Federal estimated tax payments (assuming they are paid by ~Apr 15) are typically much less than a typical Credit Card would charge.

I use to fret about this in the past. Now I don't worry so much.

-gauss

[rayvt]

Quote:

Originally Posted by Koolau Were this a withdrawal, that would work (at least for the Feds). Since it's a conversion, I don't know of any way to "withhold" taxes.)

At etrade, the on-line form for a Roth conversion has a box for you to fill in how much you want to be withheld. (Obviously, that has to be cash.) I recently did a conversion and had 92% withheld. The alternative was to have more withheld out of each monthly pension or SS check.

Quote:

(I'd rather pay the taxes from other funds and convert the entire amount.)

Money is fungible. You have to pay the tax no matter what, and it has the same effect on your net worth no matter where that money comes from. The main (only?) benefit to paying the tax for a Roth conversion from other funds is that it effectively lets you contribute that amount to your Roth.

[RunningBum]

Quote:

Originally Posted by rayvt At etrade, the on-line form for a Roth conversion has a box for you to fill in how much you want to be withheld. (Obviously, that has to be cash.) I recently did a conversion and had 92% withheld. The alternative was to have more withheld out of each monthly pension or SS check. Money is fungible. You have to pay the tax no matter what, and it has the same effect on your net worth no matter where that money comes from. The main (only?) benefit to paying the tax for a Roth conversion from other funds is that it effectively lets you contribute that amount to your Roth.

Not true. Money in your Roth is worth more than the same amount elsewhere because the gains on it will never be taxed. Create a spreadsheet with 2 options--paying taxes out of your conversion, and paying it out of a taxable account. Then choose a rate of return for the next 10 years, and see how those two scenarios perform. As long as your return rate is > 0%, the second scenario will give you more money.

[kaneohe]

Quote:

Originally Posted by rayvt At etrade, the on-line form for a Roth conversion has a box for you to fill in how much you want to be withheld. (Obviously, that has to be cash.) I recently did a conversion and had 92% withheld. The alternative was to have more withheld out of each monthly pension or SS check. Money is fungible. You have to pay the tax no matter what, and it has the same effect on your net worth no matter where that money comes from. The main (only?) benefit to paying the tax for a Roth conversion from other funds is that it effectively lets you contribute that amount to your Roth.

You could do the withholding on the conversion (to get the benefit of "timely" payments) and replace the missing withholding into the Roth IRA within 60 days (as a rollover to get the Roth back to its available size).

[Taxman59]

If you convert IRA money to a ROTH, and you have taxes withheld, the amount withheld is treated as a distribution and potentially subjecting you to penalties for early withdrawal.

[user5027]

Quote:

Originally Posted by Taxman59 If you convert IRA money to a ROTH, and you have taxes withheld, the amount withheld is treated as a distribution and potentially subjecting you to penalties for early withdrawal.

If you are under age 59.5 years.

[kaneohe]

Quote:

Originally Posted by Taxman59 If you convert IRA money to a ROTH, and you have taxes withheld, the amount withheld is treated as a distribution and potentially subjecting you to penalties for early withdrawal.

Yes, as pointed out by user,if you don't complete the rollover on a timely basis. However a usually reliable source says that the penalty is not assessed if the rollover is completed on time.

[misanman]

Quote:

Yes, as pointed out by user,if you don't complete the rollover on a timely basis. However a usually reliable source says that the penalty is not assessed if the rollover is completed on time.

This doesn't seem reasonable to me. Why wouldn't taxes withheld always be counted as an TIRA distribution? Or are you saying that you would convert the whole amount and then immediately withdraw the taxes from the Roth?

[kaneohe]

Quote:

Originally Posted by misanman This doesn't seem reasonable to me. Why wouldn't taxes withheld always be counted as an TIRA distribution? Or are you saying that you would convert the whole amount and then immediately withdraw the taxes from the Roth?

Consider a slightly different situation. You withdraw from TIRA and withhold taxes . Within 60 days you replace the whole withdrawal amount back into TIRA. When you look at the beginning and ending situations, the TIRA looks the same. All that is different is that IRS has your withholding and your bank
account is different by that same amount. It is as if you paid IRS estimated taxes except you get the benefit of it being considered withholding. Since you completed the TIRA rollover in time, no early withdrawal penalty.

Don't know if that makes any more sense..........something that some creative
person(s) devised to make a withholding which counts as evenly paid throughout the yr. Of course,it's use is more restricted these days since you can only do 1 rollover/12mos.