Over withholding taxes on Roth conversion

[meleana]

What happens if you over withhold taxes from a Roth conversion account?

After looking at last years tax return, my FA said to withhold 10 % instead of 12 % ( our tax bracket). He said if anything we’d only owe a little bit in April if at all. I asked him wouldn’t it all rectify itself anyway when doing the taxes and if we overpaid we’d get reimbursed excess taxes paid overall when we filed? He said no.

I don’t get it. Can anyone else chime in on this?

( And yes- we will be paying the taxes out of the conversion account even though we have cash to pay them because that’s the way we want to do it so we’ve already decided on that).

 

[MarieIG]

Nope, I can't. He probably finds it to be inefficient, and has determined you will not be penalized in any manner due to his instructions.

What I can say, my CPA hates it when I over estimate tax payments. He wants me to have every possible penny in hand. Possibly your financial adviser is the same?

 

[latexman]

I think your FA is wrong, but I will follow this thread to see what others say.

I do understand why one wouldn't want to do this, but his answer to your question is wrong.

 

[qwerty3656]

The argument I have heard is if you're getting a refund that means you've made an interest free loan to the government.

 

[Sunset]

OP - your FA is wrong, when you do your taxes, you will get back all your over payment if any.

I used to try to calculate exactly what our taxes would be, and then one year paid a few hundred in penalties due to surprise income. Now I just pay 110% of last years taxes and it gets balanced out when we do our return.

I'd be worried about the advice of an FA that doesn't even know such a basic thing...

 

[SecondCor521]

After looking at last years tax return, my FA said to withhold 10 % instead of 12 % ( our tax bracket). He said if anything we’d only owe a little bit in April if at all. I asked him wouldn’t it all rectify itself anyway when doing the taxes and if we overpaid we’d get reimbursed excess taxes paid overall when we filed? He said no.

If I understand what you're saying he's saying, he's wrong and you're right.

Your total tax will be on line 24 of your Form 1040. Any withholding will be entered on line 25 and will be included in your total payments on line 33. Any excess will be refunded to you on lines 34 and 35. It's really straightforward math.

FAs are notoriously bad at taxes in my experience.

Ask a CPA or professional tax preparer the same question and I bet you'll get a different answer.

 

[meleana]

Nope, I can't. He probably finds it to be inefficient, and has determined you will not be penalized in any manner due to his instructions.

What I can say, my CPA hates it when I over estimate tax payments. He wants me to have every possible penny in hand. Possibly your financial adviser is the same?

Yes. This I get and am ok with it, but what I’m questioning is his statement that you would not recoup the money when filing the taxes.

I have an inherited IRA that has the taxes taken out of the annual RMDs and for years at a higher tax rate than required now that we are in a low bracket. These past few years in retirement and 12 percent tax bracket we were getting nice refunds and then I realized I never changed the withholding percentage on those RMDs. Now that I’ve done so, I don’t anticipate having those refunds any longer. Come to think of it, I wonder if I should mention this to my FA because I’m sure he doesn’t realize that affected last year’s return that he’s basing his recommendation on as well)

 

[thod]

Correct me if I misunderstand this, but I do see a reason he might be right.

Since your talking about a Roth conversion and you are paying the taxes out of the conversion, then any overpayment for the tax year, would imply that you could have converted the overpayment amount to the Roth, instead of getting it in cash via the tax refund.

So, what is more important, getting the money into the Roth or having the money outside of the Roth (to invest or spend). Either way it is yours. Assuming you might invest it in a taxable anyway, then the comparison would be having the excess invested for tax free growth or taxable growth.

If you intend to spend it and not invest it anyway, then I do not think it matters.

 

[MarieIG]

Yes. This I get and am ok with it, but what I’m questioning is his statement that you would not recoup the money when filing the taxes.

I have an inherited IRA that has the taxes taken out of the annual RMDs and for years at a higher tax rate than required now that we are in a low bracket. These past few years in retirement and 12 percent tax bracket we were getting nice refunds and then I realized I never changed the withholding percentage on those RMDs. Now that I’ve done so, I don’t anticipate having those refunds any longer. Come to think of it, I wonder if I should mention this to my FA because I’m sure he doesn’t realize that affected last year’s return that he’s basing his recommendation on as well)

Yes, of course you do! Maybe he's thinking lost opportunity?

Yes, that does seem prudent.

 

[audreyh1]

In general, isn’t it better to not withhold anything from a Roth conversion unless you really don’t have the funds in taxable accounts to cover the taxes owed?

That way you can maximize the conversion for future tax-free growth.

 

[meleana]

Correct me if I misunderstand this, but I do see a reason he might be right.

Since your talking about a Roth conversion and you are paying the taxes out of the conversion, then any overpayment for the tax year, would imply that you could have converted the overpayment amount to the Roth, instead of getting it in cash via the tax refund.

So, what is more important, getting the money into the Roth or having the money outside of the Roth (to invest or spend). Either way it is yours. Assuming you might invest it in a taxable anyway, then the comparison would be having the excess invested for tax free growth or taxable growth.

If you intend to spend it and not invest it anyway, then I do not think it matters.

Yes. Right. I thought of this as well. But really we are not converting that much money at once. Only about $50,000 or so each year for 4 years. So it’s not
“big” money in taxes. Supposedly in our case the Roths should be the last thing we ever touch in retirement and we are already in our late 60’s with big tIRA accounts. We have one child that inherits what’s ever left when we pass- if anything. That’s why I really don’t care if less money goes into the Roth after conversion. ( I do hate having to “ sell” in the down market to do this but at least converting in a down market is a good thing) I like having my cash, especially during times like this.

 

[RunningBum]

Yes. Right. I thought of this as well. But really we are not converting that much money at once. Only about $50,000 or so each year for 4 years. So it’s not
“big” money in taxes. Supposedly in our case the Roths should be the last thing we ever touch in retirement and we are already in our late 60’s with big tIRA accounts. We have one child that inherits what’s ever left when we pass- if anything. That’s why I really don’t care if less money goes into the Roth after conversion. ( I do hate having to “ sell” in the down market to do this but at least converting in a down market is a good thing) I like having my cash, especially during times like this.

But you are selling whether you pay taxes via withholding from the Roth conversion (the tax money comes from part of the converted holdings) or by selling some taxable assets to pay the taxes as an estimated tax payment. Just because selling via tax withholding is a more passive action to you doesn't make it any less of a sale in a down market.

You are correct that conversions in a down market is a good thing, because you can convert more shares of whatever you converting with your $50,000 conversion.

And of course you are also correct that any over withholding does get rectified at tax time. The FA may have meant that the refund does not go into your Roth, but rather your taxable account. I hope that's what he meant, and he should have been more clear about that. If he really thinks it's lost, he's a financial salesman, not an advisor.

 

[MarieIG]

In general, isn’t it better to not withhold anything from a Roth conversion unless you really don’t have the funds in taxable accounts to cover the taxes owed?

That way you can maximize the conversion for future tax-free growth.

That's my opinion, although others may opinione differently . . .

 

[RetiredAndLovingIt]

I think he means that any overpayment that you make has now lost its tax free status and can't be redeposited back into your tax deferred accounts. Always best to pay with taxes from your savings if possible.

 

[meleana]

In general, isn’t it better to not withhold anything from a Roth conversion unless you really don’t have the funds in taxable accounts to cover the taxes owed?

That way you can maximize the conversion for future tax-free growth.

Yes. This is what they say and I’m sure it’s right but I simply don’t want to. I like the simplicity of paying out of the converted account, not having to deal with estimated taxes, and keeping our liquid cash on hand for whatever for the next few upcoming years in our 12 percent tax bracket and before SS at ages 70 and RMDs kick in at 72. ( which, who knows could increase to an older age by then).

Plus the whole growth thing is suspect in a short window of time when you’re older. Right now I look at some of our investments in our IRAs and our personal rate of return and the so called growth is not such a big deal. Ok- we were a bit on the conservative side of balanced. Heck we could be dead by the time the markets go back to where they once were.

But having the extra cash to take a trip or buy a new car or give a gift to our son or maintenance on our house if needed or whatever other splurges - and also for other investments like I bonds or treasuries, etc.- I like not having to dip into our tIra or 401k funds prematurely or sell off securities in our tax efficient brokerage account before we finish these conversions or have to do RMDs. And taking money out of our Roth for that stuff defeats the point of the conversions in the first place and not touching the Roths as a last resort in our retirement plan as per our FA.

He prefers we pay the taxes out of our taxable accounts but he also said this is fine also and in fact even if we didn’t do the conversions we will be just fine. But he feels doing them is still a good idea so we are but our happy medium is paying the taxes out of the converted account. ��

 

[Al18]

I’ve been doing Roth IRA conversions of about 50K per year up to the top of the 12% bracket and also withholding taxes out of the conversion. As others have stated, you will get any tax overpayment refunded when you file your taxes. I can confirm I pay about 8.5% in federal taxes, so the 10% withholding recommendation seems about right.