Traditional to Roth: Withholding Discoveries

[sengsational]

I just got off of the phone with Fidelity after having done my annual traditional IRA to Roth IRA conversion. I learned some things that might be old news to some, but it was new news to me.

The first thing was that they said the minimum percentage withholding was 10% (my tax modeling said I should set it to about 2.5%). So I cooked up a scheme right there on the phone where I'd do two conversions, one small one with 10% withholding, and one larger one with no withholding. But I didn't execute on this because of the next thing I learned.

The second thing that they said was that if they are to pay the IRS withholding associated with this transaction, the money must come out of the tIRA account (I wanted to pay with after tax money out of my regular brokerage account, but they said that wasn't possible). I was concerned about this for two reasons. First, the amount out of the tIRA would be greater than went into the Roth (so probably the withholding amount would be subject to the 10% penalty and taxes on gains). Second, the withholding amount is paying taxes with tax advantaged money, in escence, reducing my tax advantaged pot of money by the withholding amount. This would not be true if I just paid the same amount in estimated taxes or on April 15.

So the result was that I did my conversion with no withholding and will either send in an estimated payment or just wait for April and hope I avoid penalty for underpayment (it's not much of an underpayment since I had W2 withholding in January).

So next time you read "all you have to do is..." withhold from your Roth conversion, you might need to consider the above limitations.

 

[kramer]

I recently did my first tIRA to ROTH conversion with Vanguard and their wording on this I found very tricky. Luckily, I didn't have to mess with that because I pay all taxes from my taxable account only.

However, as you stated in your excellent post, the withholding is from the transaction itself (in other words, from the tIRA), not your taxable account, so it pays to be extra, extra careful.

I was almost going to post about this and I am glad you did that.

 

[kaneohe]

...................................
So next time you read "all you have to do is..." withhold from your Roth conversion, you might need to consider the above limitations.

Don't believe I've ever read that re: Roth conversions tho w/ my aging memory that doesn't mean much...............usually I've read about withholding from
TIRA RMDs late in the year since withholding is considered as being taken throughout the year.

Another thing I've read is that you can replace the withholding taken from the TIRA (not related to RMDs here) if done within 60 days. Perhaps not so useful in the future since you can only do 1 such indirect rollover each 365 days.

 

[pb4uski]

I have never had taxes withheld from Roth conversion and just paid any taxes separately from taxable accounts as a separate transaction. Perhaps I'm just a control freak.

 

[jebmke]

I have never had taxes withheld from Roth conversion and just paid any taxes separately from taxable accounts as a separate transaction. Perhaps I'm just a control freak.

Same here. One of the major advantages of doing a conversion is being able to move the IRS's share of the IRA into my share (out of taxable).

 

[Midpack]

I just got off of the phone with Fidelity after having done my annual traditional IRA to Roth IRA conversion. I learned some things that might be old news to some, but it was new news to me.

The second thing that they said was that if they are to pay the IRS withholding associated with this transaction, the money must come out of the tIRA account (I wanted to pay with after tax money out of my regular brokerage account, but they said that wasn't possible).

Based on the reply below and several other sources, it appears the Fidelity rep misled the OP, unless there was something unique about the OP's circumstances that I've missed.

I have never had taxes withheld from Roth conversion and just paid any taxes separately from taxable accounts as a separate transaction. Perhaps I'm just a control freak.

 

[Texas Proud]

I am also one who has converted without any withholding.... but it was Vanguard....


I would have gone up level if you think the answer is wrong.... I did that with my 401(k) for a different reason and found out I was correct.... was told that the first rep that steered me wrong would be 'retrained'....

 

[kaneohe]

Based on the reply below and several other sources, it appears the Fidelity rep misled the OP, unless there was something unique about the OP's circumstances that I've missed.

or perhaps not..............maybe pb4uski could share with us how he how he paid his tax......" just paid any taxes separately from taxable accounts as a separate transaction....................................did you have withholding done on a taxable distribution from a taxable account such as capital gains/dividend distribution or was withholding done on a cash withdrawal from your account? If the latter, I wasn't aware that withholding could be done since that would seem a sneaky way to avoid paying estimated taxes?

Hard to tell for sure but it sounds like sengsational wanted to do the latter.

Also it is possible that sengsational's OP was unintentionally misleading. I doubt that he meant to say that withholding was mandatory with a 10% minimum. More likely he meant to say that if you want to withhold, the minimum is 10% but that you can also withhold 0%. His clever 2 part strategy that he did not execute suggests that he knew about 0% withholding.

 

[youbet]

This seems to be getting way more complicated than necessary.........

I do Roth conversions with zero withholding and then add the amount of the conversion to the taxable income number I use to calculate that quarter's estimated tax payment. Done.

I have to calculate and send in the estimated tax payment regardless. This just gives me a different number to work with but no extra work.

 

[pb4uski]

I have never had taxes withheld from Roth conversion and just paid any taxes separately from taxable accounts as a separate transaction. Perhaps I'm just a control freak.

Based on the reply below and several other sources, it appears the Fidelity rep misled the OP, unless there was something unique about the OP's circumstances that I've missed.

or perhaps not..............maybe pb4uski could share with us how he how he paid his tax......" just paid any taxes separately from taxable accounts as a separate transaction.............................

Yes, when I saw Midpack's response I knew that I perhaps was not clear. I do my Roth conversion with no withholding. Separately, I just incorporate whatever taxes would be due on the Roth conversion in my next estimated tax payment which comes out of my bank account (not my brokerage account).

 

[kaneohe]

This seems to be getting way more complicated than necessary.........

I do Roth conversions with zero withholding and then add the amount of the conversion to the taxable income number I use to calculate that quarter's estimated tax payment. Done.

I have to calculate and send in the estimated tax payment regardless. This just gives me a different number to work with but no extra work.

So do you send in "lumpy" quarterly payments instead of equal ones? The safe harbor is if you send in equal ones so if you send lumpy ones, do you file F2210 with in Sch AI or do you just assume you're small potatoes and IRS won't bother?

 

[pb4uski]

I use the annualized income installment method (lumpy in your lexicon). In fact, because we're living on taxable accounts, our tax liability would be nil without any Roth conversion because our income is so low and it is predominately qualified dividends. I wait until December to 1) rebalance to bring cash back to 6% (~ two years of withdrawals) which tells me what our capital gains for the year are, know what year end dividend distributions are and then I determine how much of a Roth conversion we can do and I do it and then make my federal and state estimated tax payments.

I do file a 2210 and similar state form. With Quicken information it is pretty easy to take out taxable income and spread it across the relevant quarterly periods (which unfortunately don't align with calendar quarters). It is a bit of a PITA but now that i have a spreadsheet set up for it and our return is fairly straightforward not a huge chore.

Edit: Oops, I just noticed that your question was to youbet and not me, but I'm guessing that youbet and I have similar approaches.

 

[youbet]

So do you send in "lumpy" quarterly payments instead of equal ones? The safe harbor is if you send in equal ones so if you send lumpy ones, do you file F2210 with in Sch AI or do you just assume you're small potatoes and IRS won't bother?

Just been running under the radar I guess........ No F2210.

I file "lumpy" quarterly payments in proportion to the taxable income I have for that quarter. Annual estimated payments are about one half of the total with the balance coming from withholding.

I'm not sure what the IRS would come after me for since my payments are always timely in respect to my income. I thought their concern was when you had income early in the year and did not make the estimated tax payment until late in the year causing poor uncle to wait for his money.

 

[kaneohe]

Thanks, pb4uski and youbet. I was curious because I did Sch AI once and thought it was like doing taxes 4x so I try to avoid it if I can . I was concerned that even I paid my lumpy installments on time and of the right amount I would still have to prove it to them.

 

[pb4uski]

I've never had an inquiry from the feds, I suspect because the 2210 is file along with my tax return. OTOH, I now have a friendly relationship with one of our state tax examiners but everything has worked out well.

 

[sengsational]

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Yep, the Fido rep said if I wanted to have withholding, the smallest percent wouldbe ten. Then offered to no withholding option. Sorry if that wasn't clear.