Roth IRA from Traditional IRA Transfer

[beachbaker]

Hello, I was wondering if I take a withdrawal from my Traditional IRA and have it transferred to my Roth do I have to estimate taxes due and immediately pay them? This is a Vanguard account so the transfer is easy but if I do this in January what does the IRS require. Thanks, Curt

 

[SecondCor521]

You don't *have* to. But you might *really want* to.

Doing what you're describing is usually called a Roth conversion. The amount you transfer will go on line 4b of your 1040 and you'll owe ordinary income taxes at both the federal and state level on the amount transferred.

If you don't make an estimated tax payment, then you may be subject to underwithholding penalties at the federal level (and possibly at the state level as well). You'll be subject to penalties, generally speaking, if you didn't withhold enough at the right time to meet any of the safe harbor rules. This will depend on your total tax picture, of course, but a large conversion in January relative to your other income and not making an estimated tax payment virtually guarantees that you'll owe the penalty.

The penalties are not horrifically bad, but they're avoidable with a moderate amount of effort, so most people learn the rules and make the estimated payments or ensure they have enough withheld to meet one of the safe harbor rules.

Note that if you do this in January then the income is treated as 2021 income and would go on your 2021 tax return which you would file in spring 2022.

 

[2017ish]

If you are not yet retired, you can adjust your withholding at work to avoid estimated taxes. Otherwise, what SecondCor521 said.

 

[CyclingInvestor]

To avoid the penalties and extra paperwork, I just have the fed/state taxes withheld when making the transfer.

 

[Al in Ohio]

I think it would be more straightforward to just complete a ROTH conversion form.

 

[Brat]

I have a chunk of change in my checking account. I paid state and federal income taxes on the conversion out of that account. My goal was to maximize the value of the conversion while meeting my income tax obligations. It is amazing how easy direct payment is these days.

 

[JoeWras]

To avoid the penalties and extra paperwork, I just have the fed/state taxes withheld when making the transfer.

Caution! Be careful with this if you are under 59 1/2.

I think our OP is over that age. Just sayin' for the youngsters reading this thread.

 

[Whisper66]

Don't know your situation, this is ours for comparison. We are retired, rely on a tax accountant to help us avoid tax penalties, and we pay quarterly estimated taxes each year. At the beginning of 2020 we planned to make a very large Roth conversion which would make up most of our "income" for tax purposes. Our tax accountant calculated our estimated taxes which were then evenly split up for payment each quarter. There is a IRS form (1040-ES, Estimated Tax Worksheet) that shows the calculation basis and is used to ensure proper rules are followed. Later in 2020, we chose to make two more relatively large Roth conversions. The taxes for each were paid in the quarterly payment following the conversions. Per our tax accountant, there will be no penalty if we do it this way.

 

[RunningBum]

Don't know your situation, this is ours for comparison. We are retired, rely on a tax accountant to help us avoid tax penalties, and we pay quarterly estimated taxes each year. At the beginning of 2020 we planned to make a very large Roth conversion which would make up most of our "income" for tax purposes. Our tax accountant calculated our estimated taxes which were then evenly split up for payment each quarter. There is a IRS form (1040-ES, Estimated Tax Worksheet) that shows the calculation basis and is used to ensure proper rules are followed. Later in 2020, we chose to make two more relatively large Roth conversions. The taxes for each were paid in the quarterly payment following the conversions. Per our tax accountant, there will be no penalty if we do it this way.

Maybe. Maybe not. There may be other factors in your case of why there is no penalty, like perhaps you met safe harbor with the original planned quarterly payments.

Let's take an example where your early conversion generated a $40K tax liability, and you didn't have safe harbor on your taxes paid last year. Then in Q3 and Q4 you do more conversions, with a $10K liability on each. No other income tax due, for simplicity.

Initially you set up to do quarterly payments of 10K/10K/10K/10K. That's fine so far, because you made even payments, and the IRS accepts it with no other information such as the date the income was realized. They assume it was spread out over the year.

Now in Q3 and Q4 you make additional conversions, and payments for them. So your quarterly payments are now 10K/10K/20K/20K. Now the IRS has an issue with this, because you didn't spread your payments evenly. They want to see 15K/15K/15K/15K, OR they want you to fill out form 2210 to show when the income was realized, and that taxes were paid accordingly each quarter.

For form 2210, you would show the first conversion in Q1, and two others in Q3 & Q4. It will say you should have made a $40K payment at the end of Q1, nothing in Q2, then $10K each in Q3 and Q4.

Either way you're short on making timely tax payments, and would likely have some penalty+interest added when you do your taxes.

This is why the safest thing is to pay your estimated taxes for the income you take in each quarter at the end of that quarter, unless you know with pretty good accuracy what your end of year tax liability would be.

That's my understanding anyway. I wouldn't blame you for being skeptical that I know better than your tax accountant, but as I said, there might be another reason why they are saying your fine with this method, and didn't bother to explain it to you.

 

[Whisper66]

Maybe. Maybe not. There may be other factors in your case of why there is no penalty, like perhaps you met safe harbor with the original planned quarterly payments.......

Interesting point so I went back and checked ... our initially planned quarterly tax payments set up by the tax advisor were set up to meet the safe harbor rule. Thanks for the comment. I will keep it in mind for next year when I also plan a large early conversion but don't plan to meet the safe harbor rule.

 

[crow]

I do a Traditional to Roth conversion to the top of the 12% tax bracket every year. This causes me to owe abut $8400 in federal taxes. Starting in June, I have $1100 held from my pension check every month. This keeps me within safe harbor limits.

 

[Miarocks]

If you are not yet retired, you can adjust your withholding at work to avoid estimated taxes. Otherwise, what SecondCor521 said.

Even if you are already retired, if you receive a pension (or perhaps even with Social Security), you can adjust your withholding there, too. That’s what we’ve done this year to cover our IRA conversion taxes. Seems less painful to me to have it paid in monthly and have the steady income.

 

[beachbaker]

I have to thank you all for your knowledgeable replies. I am retired as well as my wife as we are 72 and 68 respectively. I am trying to empty my Traditional IRA as quick as possible as my wife will have RMD's in four years and our income at that time will balloon. She also will take her SS at 70 and I expect with those together our taxes will jump. So, if I do the transfer in January I can take the estimated taxes out of my personal account and pay in entirety by the end of March? Thanks, Curt

 

[Miarocks]

To avoid the penalties and extra paperwork, I just have the fed/state taxes withheld when making the transfer.

But then you don’t have the full amount of the transfer working for you in your Roth investment. IMO it’s better to pay the taxes from an outside source if possible. We did it this way, by choosing to adjust the withholding on our pensions in lieu of paying estimated tax.

 

[RunningBum]

I have to thank you all for your knowledgeable replies. I am retired as well as my wife as we are 72 and 68 respectively. I am trying to empty my Traditional IRA as quick as possible as my wife will have RMD's in four years and our income at that time will balloon. She also will take her SS at 70 and I expect with those together our taxes will jump. So, if I do the transfer in January I can take the estimated taxes out of my personal account and pay in entirety by the end of March? Thanks, Curt

Yes. You actually have until April 15 to pay 1Q taxes. https://www.eftps.gov/eftps/ is a handy site to do it online, and you can schedule payments through it so you don't forget.

 

[deserat]

For form 2210, ....

This is why the safest thing is to pay your estimated taxes for the income you take in each quarter at the end of that quarter, unless you know with pretty good accuracy what your end of year tax liability would be....

^^^^^ As a sometime consultant and IRA2Roth converter when it suits me, I am willing to do the form 2210. The assumption that my income is consistent year-to-year is not a good one and I can't pay taxes on earnings I don't have. I do quarterly taxes on my self-employed and conversion income in the quarter they are realized and if needed include the 2210 in the 15 April yearly final summing up.

My income has jumped around *a lot* over the years, so safe harbor is difficult to determine....

Also, I may not decide to do a Roth conversion one year or two years...or whenever.

As long as the IRS gets their cut during that quarter the income was realized, it should be OK. The paperwork isn't too onerous and it also affords the taxpayer yet another opportunity to reflect on taxes, how they are computed and whether or not one receives what they are paying for. I'm all for an 'informed citizenry' and intend to be one.

 

[pb4uski]

To avoid the penalties and extra paperwork, I just have the fed/state taxes withheld when making the transfer.

Withholding from the amount converted is a bad way to pay the taxes unless one has no other choice.

If you have earnings then you can adjust your withholdings. Or make estimated tax payments.

And as Joe mentioned, if you are less than 59 1/2 then the withholding is a withdrawal and not only subject to tax but also a 10% early withdrawal penalty.

 

[CyclingInvestor]

Withholding from the amount converted is a bad way to pay the taxes unless one has no other choice.

If you have earnings then you can adjust your withholdings. Or make estimated tax payments.

And as Joe mentioned, if you are less than 59 1/2 then the withholding is a withdrawal and not only subject to tax but also a 10% early withdrawal penalty.

I have "converted" all my post-tax savings into my Roth during the last 3 years (after attaining 59.5), by spending them down while letting the conversions pile up in my Roth, so all of my assets are now in my tIRA and my Roth, so at this point withholding on the conversion make the most sense.

 

[pb4uski]

I agree that if you have no taxable account money to pay that taxes that witholding on the conversion makes the most sense because it is your only choice and Roth conversions with withholdings is better than no Roth conversions at all.

Note that I wrote:

Withholding from the amount converted is a bad way to pay the taxes unless one has no other choice. ...

It sounds like the OP has taxable account money to pay the taxes so he would be best off doing what you did when you had taxable account money to pay the taxes.