Paying taxes on Roth conversions

[Cobra9777]

Doesn't the withdrawn amount count against your AGI?

No. There's no effect on AGI. It's a non-taxable 60-day rollover.

 

[braumeister]

No. There's no effect on AGI. It's a non-taxable 60-day rollover.

The phrase "fiendishly clever" comes to mind.

 

[Koolau]

The phrase "fiendishly clever" comes to mind.

Beating them at their own game. SHhhhhhhh!!! Someone in gummint is probably listening.

 

[engineernerd]

so no 1099-R gets generated that shows taxable income, as with normal traditional IRA to Roth IRA conversions?

Every penny of a Roth conversion is taxable income in the year you withdraw the funds from your tIRA. That's true no matter the details of how you pay the taxes.

What some here have pointed out is that you could do a Roth conversion early in the year, sending all the funds from the tIRA to the Roth account with no tax withheld, then sit tight until December and do a 60-day tIRA (to tIRA) rollover whose sole real purpose is to have whatever amount of tax withheld you need withheld for that year. As long as you put the money back into a tIRA within the 60-day deadline, AND you have not done a previous tIRA-to-tIRA 60-day rollover within the 12 months before that one, THAT transaction generates no tax liability whatsoever.

At least, that's how I understand it.

 

[meleana]

We pay out of the conversion despite the recommendation not to. Easy peasy and no worries. Barely even notice it.

 

[jazz4cash]

We pay out of the conversion despite the recommendation not to. Easy peasy and no worries. Barely even notice it.

This is what I have always believed. I am not clear on why it is not recommended except of course the conversion is a bit smaller. Someone mentioned the payment is subject to an early withdrawal penalty if <59.5 but that does not apply to me.

 

[engineernerd]

I am planning on pretty aggressive Roth conversions again this year. I am planning to do multiple conversions but hate paying quarterly taxes. Can someone explain the strategy to do a year end conversion for taxes to avoid having to pay estimated taxes throughout the year?

What you do is take a distribution from a tIRA, requesting that a certain amount (as much as you need, but obviously not more than the full distribution amount or 99% of the distribution amount if that's the rule at your custodial firm) be withheld for taxes and the rest be sent to you in some way (mailed check, transfer to checking, transfer to brokerage settlement fund).

Then, no more than 60 days after the date of that distribution, you deposit the full amount of the distribution into a Roth IRA in your name, asking the custodian to characterize it as a rollover contribution. The funds come from your taxable brokerage account or your checking or savings account.

In reality you end up having paid your taxes from your taxable account(s). And those taxes are withheld rather than being paid as quarterly estimated taxes.

 

[engineernerd]

We pay out of the conversion despite the recommendation not to. Easy peasy and no worries. Barely even notice it.

But your Roth balance ends up lower than it could have been, so the future earnings will be less than they could have been. The time when you will notice the difference is not now, it's when you start withdrawing from your Roth IRA(s) years or even decades from now.

If you pay the IRS from a taxable account, you forego the future earnings on that amount invested in that account. If you pay the IRS from your Roth account, you will forego the future earnings from that amount invested in the Roth account. Since the former will be taxed and the latter won't, it seems smarter to pay the taxes from a taxable account.

 

[SecondCor521]

If you pay the IRS from a taxable account, you forego the future earnings on that amount invested in that account. If you pay the IRS from your Roth account, you will forego the future earnings from that amount invested in the Roth account. Since the former will be taxed and the latter won't, it seems smarter to pay the taxes from a taxable account.

True, as long as you have enough in taxable to pay the taxes on the conversion. I do, but some folks might not for whatever reason; most plausible scenario I can imagine is someone who is in their early 80s who has done a lot of Roth conversions over the prior 10-15 years and has depleted their taxable account.

Still not a problem, but in that scenario paying the taxes from the conversion itself still might be worthwhile depending on tax rates now and later.

 

[Ultrac]

We have 2 pensions, dividends, Roth conversions throughout the year, and some hobby income. We have no withholding and no quarterly estimated payments.

Like others, I withdraw our safe harbor amount from a tIRA each December, instructing Fidelity to withhold 100%. Following January, I repay the IRA from taxable funds and instruct Fidelity to code it as a 60-day rollover. So the original tIRA withdrawal is non-taxable... like it never happened.

In effect, we use taxable funds to pay tax each January for the prior year. But it's deemed to have been withheld equally throughout the prior year. So no worries about underwithholding or filing Form 2210 (AI). The process is simple and the cash flow is quite favorable.

To avoid complications associated with the once-per-year restriction on rollovers, I alternate between my IRA and DW's IRA.

Thank you for providing this information.


Please can you clarify what you mean by "instructing Fidelity".


I understand you do this twice, once to determine the withholding percentage and then again in January to code as a rollover.


Is this something you do online or do you have to call them? If you call them, what exactly do you say.


Thanks.

 

[TheWizard]

But your Roth balance ends up lower than it could have been, so the future earnings will be less than they could have been. The time when you will notice the difference is not now, it's when you start withdrawing from your Roth IRA(s) years or even decades from now.

If you pay the IRS from a taxable account, you forego the future earnings on that amount invested in that account. If you pay the IRS from your Roth account, you will forego the future earnings from that amount invested in the Roth account. Since the former will be taxed and the latter won't, it seems smarter to pay the taxes from a taxable account.

It depends on your situation: how huge your tax-deferred account is compared to your taxable account.

Nowadays, I just do a smallish Roth conversion at year end, after completing my RMD. So am I paying the tax on that Roth conversion from my RMD, my SS, or my pension/annuity income?
It doesn't matter.

My taxable account is growing more than my Roth account at this point and I don't envision drawing either of them down significantly in future years.
As I said, situations vary...

 

[Midpack]

but statistically you forego tax-free growth in your Roth by waiting so long into the year.

converting at the beginning of the year is the optimal approach based on back-testing.

paying the taxes owed on that conversion contemporaneously via electronic payment is trivial.

as for the annualization method to avoid penalties, my CPA does that, don't the popular tax software packages offer that as well?

+1. I convert 80%+ in Jan, and then do my final amount in Dec after I’ve seen all my dividends, gains etc. so I know exactly where my MAGI will be (for tax bracket, IRMAA, etc.). Why have growth in my TIRA when it can be in my Roth all year? I pay estimated taxes quarterly, it’s a piece of cake doing Fed and state withholding online.

 

[Cobra9777]

...Please can you clarify what you mean by "instructing Fidelity".


I understand you do this twice, once to determine the withholding percentage and then again in January to code as a rollover.


Is this something you do online or do you have to call them? If you call them, what exactly do you say...

The December withdrawal can be done online. But the online functionality is limited to 99% withholding. They can do 100% (which I prefer), but you have to call and have an agent do the transaction for you. I just say something like, "I'd like to withdraw $X from my IRA ending in xxxx, with 100% withholding." They might ask, "So, you want 100% of the withdrawal to go directly to the IRS?" Yes.

As for the January repayment/rollover, I'm not aware of any way to do this online (coded as a 60-day rollover). Oddly, there is a paper deposit form with a checkbox for 60-day rollover. But again, I call and say something like, "I'd like to transfer $X from my cash management account ending in xxxx into my IRA ending in xxxx, coded as a 60-day rollover." They usually ask, "Have you made a 60-day rollover in the last year?" No.

 

[Koolau]

But your Roth balance ends up lower than it could have been, so the future earnings will be less than they could have been. The time when you will notice the difference is not now, it's when you start withdrawing from your Roth IRA(s) years or even decades from now.

If you pay the IRS from a taxable account, you forego the future earnings on that amount invested in that account. If you pay the IRS from your Roth account, you will forego the future earnings from that amount invested in the Roth account. Since the former will be taxed and the latter won't, it seems smarter to pay the taxes from a taxable account.

Yes. This is key. IF you can afford to pay the taxes out of non-tIRA funds, you increase the value of the Roth - giving you future tax-favorable treatment on more money. Obviously, not everyone can come up with the cash to do it this way, but I would suggest that this is the ideal. YMMV