How to pay for Roth conversions

[ER2B]

In 2018, I was converting up to the 12% and paying 4th quarter estimated tax. But now going to 22% planning to do the conversion around December this year. The materials I've read said use after tax money. I am planning to have the tax withheld by VG from the IRA during conversion. I feel it's easier and I won't have to pay a lump 4th quarter estimated tax. Plus, my taxable money will remain intact and continue to provide qualified dividends that are taxed favorably. Am I missing something.

 

[kaneohe]

1) You have 2K in taxable ,10K in TIRA. You convert 10K to Roth and pay taxes with taxable . You now have 10K in Roth.

2) You have 2K in taxable 10K in TIRA. You withdraw 10K from TIRA, convert
8K and pay 2K in taxes from TIRA w/d. You now have 8K in Roth and 2K in taxable.

The difference between the 2 examples is that 1) has extra 2K in Roth where it will grow tax free. 2)has the 2K in taxable subject to taxes . If you were <59.5 y.o. when you converted, the 2K used for taxes will have a 10% EWP
(early withdrawal penalty).

There may be some liquidity issues w/ the Roth conversions until you meet age of owner and age of Roth accounts (or penalties).

 

[GrayHare]

What kaneohe said.

Paying the tax with money from the tIRA is a losing proposition.

 

[Kwirk]

I don't see that you're missing anything but I'm no expert.

I'll be making a substantial conversion this year. My plan is to calculate what total distribution will take me (safely) near my AGI target. I'll run that number through my tax prep software to get estimates of the federal and state taxes. Then I'll do a distribution to my checking account for the total tax bump (with subsequent online payments for estimated taxes to feds and state). I'll convert the remainder to my Roth. I feel this is more precise than having taxes withheld (and I'm older than 59.5).

Edit: It would not be readily possible for me to cover the taxes with after-tax money and the goal is to eventually convert all t-ira money.

 

[RunningBum]

I wouldn't say it's a losing proposition to pay taxes from the tIRA but you are giving up the advantage to maximize what goes into the Roth. If you don't have the after-tax funds to pay the conversion tax, it's not an option, but it still may be worth converting. Hence, I object to calling it a "losing proposition".

 

[kaneohe]

..........................
I'll be making a substantial conversion this year. My plan is to calculate what total distribution will take me (safely) near my AGI target. I'll run that number through my tax prep software to get estimates of the federal and state taxes. Then I'll do a distribution to my checking account for the total tax bump (with subsequent online payments for estimated taxes to feds and state). I'll convert the remainder to my Roth. I feel this is more precise than having taxes withheld (and I'm older than 59.5).

Not familiar with the withholding system, but I think some allow you to select a % and some allow you to input a specific number to be withheld. The problem w/paying estimated taxes is that timing is a factor (when you pay). While withholding is considered paid evenly during the yr,estimated taxes are considered paid when paid so you may end up being penalized for late payments unless you complete F2210 Sch AI........that form is like doing your taxes 4x.

 

[ER2B]

Wouldn't the IRS realize that the conversion happened in December and would not penalize. How would the individual know how much to pay during the previous quarters if the conversion has not taken place yet.

 

[ER2B]

1) You have 2K in taxable ,10K in TIRA. You convert 10K to Roth and pay taxes with taxable . You now have 10K in Roth.

2) You have 2K in taxable 10K in TIRA. You withdraw 10K from TIRA, convert
8K and pay 2K in taxes from TIRA w/d. You now have 8K in Roth and 2K in taxable.

Thanks this reply cleared my head. It's really that simple. My decision making was clouded by the imbalance that I have between the taxable and tax deferred. Too much money in tax deferred.

 

[kaneohe]

Wouldn't the IRS realize that the conversion happened in December and would not penalize. How would the individual know how much to pay during the previous quarters if the conversion has not taken place yet.

Apologies for missing your DEC ref (2x !) in OP. Still, no, IRS does not know timing of "income" so assumes as default that it is paid evenly during year and then expects estimated tax to also be evenly paid. You get around that by filing F2210 Sch AI w/ all its associated "fun".

I would probably spend some time seeing what you could do w/ withholding
and see how close you could come to desired amount rather than paying est. tax.

 

[jazz4cash]

What kaneohe said.



Paying the tax with money from the tIRA is a losing proposition.

I’ll push back against this. I frequently see advice that could be interpreted this way. I agree it’s absolutely better to use taxable funds to pay taxes on the conversion if the funds are available but it’s still worthwhile to make the conversion even if you have to use tax deferred funds to pay taxes.

Unless my tax bracket drops to 0 (or maybe 12%)in retirement, chances are I will pay tax on the deferred funds at some point.

 

[GrayHare]

OK, the OP's question is not about tax rates before and after retirement. Instead the question is whether it makes any monetary difference to pay conversion tax with tIRA money or with taxable acct money. Let's see what the math says...

The OP did not state how much he would convert, so for simiplicity let's call it $1000. Also for simplicity let's assume that $1000 is his entire tIRA value, and the $220 in tax is the value of his entire taxable acct. Plus, his taxable acct gains are taxed at 15%, a common rate.

$1000 @ 22% tax = $220 tax

Scenario #1: If he pays $220 tax from taxable acct he will have
$1000 - $0 = $1000 in Roth
$220 - $220 = $0 in taxable acct
Next, 20 years pass during which the account values quadruple. He will have
$1000 in Roth x 4 = $4000
$0 x 4 = $0 in taxable acct
So his total after-tax value is $4000 + $0 = $4000

Scenario #2: If instead he pays $220 tax from from tIRA, he will have
$1000 - $220 = $780 in Roth.
$220 - $0 = $220 in taxable acct
Next, 20 years pass during which the account values quadruple. He will have
$780 in Roth x 4 = $3120
$220 x 4 = $880 in taxable acct, a taxable gain of $660
$880 - ($660 @ 15% tax) = $781
So his total after-tax value is $3120 + $781 = $3901

So, for every $1000 he converts and pays the tax from his tIRA, he loses $99. That's why I call Scenario #2 the losing proposition.

 

[ER2B]

If I make a lump sum estimated tax payment in December using my taxable account , I might not have to pay any penalty or file form 2210 due to the following quoted from the IRS:

"There are exceptions to the penalty and situations where the penalty wouldn’t apply, including: The total of your withholding and estimated quarterly tax payments was at least as much as your prior-year tax."

 

[kaneohe]

If I make a lump sum estimated tax payment in December using my taxable account , I might not have to pay any penalty or file form 2210 due to the following quoted from the IRS:

"There are exceptions to the penalty and situations where the penalty wouldn’t apply, including: The total of your withholding and estimated quarterly tax payments was at least as much as your prior-year tax."

could you provide the link to your quotation.........the prior yr safe harbor requires that your payments either be withholding or estimated payments paid in equal quarterly payments if you don't file F2210 Sch AI.

p.1 of F2210 has a flowchart that determines whether you need to file that form. The critical thing there is how your safe harbor compares w/ amount withheld. Pretty sure if you fill out that flowchart, you'll find you need to file F2210.
(or let IRS do the calculation).

 

[RunningBum]

OK, the OP's question is not about tax rates before and after retirement. Instead the question is whether it makes any monetary difference to pay conversion tax with tIRA money or with taxable acct money. Let's see what the math says...

The OP did not state how much he would convert, so for simiplicity let's call it $1000. Also for simplicity let's assume that $1000 is his entire tIRA value, and the $220 in tax is the value of his entire taxable acct. Plus, his taxable acct gains are taxed at 15%, a common rate.

$1000 @ 22% tax = $220 tax

Scenario #1: If he pays $220 tax from taxable acct he will have
$1000 - $0 = $1000 in Roth
$220 - $220 = $0 in taxable acct
Next, 20 years pass during which the account values quadruple. He will have
$1000 in Roth x 4 = $4000
$0 x 4 = $0 in taxable acct
So his total after-tax value is $4000 + $0 = $4000

Scenario #2: If instead he pays $220 tax from from tIRA, he will have
$1000 - $220 = $780 in Roth.
$220 - $0 = $220 in taxable acct
Next, 20 years pass during which the account values quadruple. He will have
$780 in Roth x 4 = $3120
$220 x 4 = $880 in taxable acct, a taxable gain of $660
$880 - ($660 @ 15% tax) = $781
So his total after-tax value is $3120 + $781 = $3901

So, for every $1000 he converts and pays the tax from his tIRA, he loses $99. That's why I call Scenario #2 the losing proposition.

Scenario 3, he doesn't convert at all. I believe the numbers will turn out the same as scenario #2. Thus, it is not a losing proposition to convert and pay taxes from the tIRA. It's not as good as scenario 1, but calling it a losing proposition implies (at least to some of us) that it's a bad idea to do it at all.

 

[2177V]

Depends on your (1) time horizon, (2) your risk tolerance, (3) your financial situation and (4) your objective.

For example: If you are in retirement or close to retirement and/or are in poor health, then your time horizon is short so you should be more conservative. If your risk tolerance is low which means you do not like volatility, then you should be more conservative. If you own a house that is NOT free and clear, and have other debts, then you depend on your portfolio for your entire retirement with no back up plan so you should be more conservative. Finally what is your objective? Is it maximum equity appreciation with accepting more risk or capital preservation to preserves your assets as your primary objective with equity appreciation a secondary objective.

I like to use 60% stock/40% bonds recommended by Vanguard or other mutual fund as a baseline starting point but then adjust my baseline according to my personal factors that I stated above. The Vanguard or Fidelity recommendation does not account for these other factors because each individual is unique.

 

[Senator]

There is only one answer for his, pay with after tax money. If you later decide you spent too much in taxes and run short, take more money out of the IRA.

It is the same as using IRA money for taxes in the first place, and gives you another option.

 

[RetireBy90]

I would suggest there are different objectives in doing the conversions.

1) Obvious is to conserve the most $$. Using after tax $$ can save you taxes and maximize your account totals. See examples above.
2) Another is to minimize paying IRMAA for Medicare. This additional cost can go from $0 to $53, to $134, to $214 to $294 per month. It can also affect if you get help with ACA premiums and can affect how much of your SS is taxable.

3) One objective for me is to minimize taxes due on your kids inheritance.

4) One other is to allow flexibility from ROTH to take as much or as little as you want in any given year without impacting taxes. If you want to buy a boat, car, or house and need to use IRA money a ROTH will allow you to not be concerned with tax implications.

I'm sure others will have other objectives such as pay while you are in a lower tax rate but just to say it isn't always a clear choice. I would rather pay a known rate today and not have to worry about what rates will be in 5, 10 or 20 years.

YMMV

 

[kaneohe]

I would suggest there are different objectives in doing the conversions.

1) Obvious is to conserve the most $$. Using after tax $$ can save you taxes and maximize your account totals. See examples above.
2) Another is to minimize paying IRMAA for Medicare. This additional cost can go from $0 to $53, to $134, to $214 to $294 per month. It can also affect if you get help with ACA premiums and can affect how much of your SS is taxable.

3) One objective for me is to minimize taxes due on your kids inheritance.

4) One other is to allow flexibility from ROTH to take as much or as little as you want in any given year without impacting taxes. If you want to buy a boat, car, or house and need to use IRA money a ROTH will allow you to not be concerned with tax implications.

I'm sure others will have other objectives such as pay while you are in a lower tax rate but just to say it isn't always a clear choice. I would rather pay a known rate today and not have to worry about what rates will be in 5, 10 or 20 years.

YMMV

1) isn't this a bit of self-delusion tho? The TIRA funds totals are "inflated" in that they are before-tax values and not really comparable to after-tax accounts directly.
2) seems a bit of a trade-off........do it now and affect ACA adversely; do it later and affect IRMAA
3) again a tradeoff..........do it now and minimize taxes your kids have to pay on inheritance...........but you are the one paying it now so it's not free..........
decision is not black and white but depends on who has the lowest tax rate
4) same as 3)

 

[RetireBy90]

1) isn't this a bit of self-delusion tho? The TIRA funds totals are "inflated" in that they are before-tax values and not really comparable to after-tax accounts directly.
2) seems a bit of a trade-off........do it now and affect ACA adversely; do it later and affect IRMAA
3) again a tradeoff..........do it now and minimize taxes your kids have to pay on inheritance...........but you are the one paying it now so it's not free..........
decision is not black and white but depends on who has the lowest tax rate
4) same as 3)

I think we mostly agree, just wanted to point out different reasons rather than just the size of the pile left.
Size does matter, just not only consideration.

1) Agree these accounts contain both your money and money that belongs to IRS. If I have after tax funds and use
them to pay the taxes, then gains from that money are tax free now as it went into the Roth. If I owe $100 in taxes
for conversion and use after tax to pay it then it doesn't earn 2% or $2 that is added to my taxable income.

2) For me, I'm paying IRMAA for wife but not for me. If I convert now, then I'll pay a higher IRMAA or ACA cost
for a few years but then may be able to save that for the rest of my life. Say 5 years aggressive conversions and then
20-25 years of less or no IRMAA. Each situation is unique of course.

3) For me, I'm leaving some on the table and want it to be tax free. Just a consideration that is not just about $$

4) I'm not sure. From a purely dollar perspective, if I take out $350K to buy a place in Main for summers that would jack the tax hit into 32% bracket (ok, only for some of it). Lots more than 22% or 24% bracket on conversions for me.

 

[LRDave]

Sorry to be thick.... If I make a sizable tIRA to Roth conversion this month, have not made estimated quarterly payments in Q1-3, my withholdings from payroll are less than the 2018 (due to a partial year of w*rk) - am I screwed by the safe harbor provision even if I make a Q4 payment ahead of the Roth conversion and generously cover the tax to be paid?

 

[kaneohe]

Sorry to be thick.... If I make a sizable tIRA to Roth conversion this month, have not made estimated quarterly payments in Q1-3, my withholdings from payroll are less than the 2018 (due to a partial year of w*rk) - am I screwed by the safe harbor provision even if I make a Q4 payment ahead of the Roth conversion and generously cover the tax to be paid?

No safe harbor for you(unless you paid nothing last yr).............however you can save yourself by proving that you paid in a timely manner tied to income stream by filing F2210 Sch AI that tracks timing of income and timing of tax payments. Not the most fun thing to do but not impossible to do.

 

[RunningBum]

Sorry to be thick.... If I make a sizable tIRA to Roth conversion this month, have not made estimated quarterly payments in Q1-3, my withholdings from payroll are less than the 2018 (due to a partial year of w*rk) - am I screwed by the safe harbor provision even if I make a Q4 payment ahead of the Roth conversion and generously cover the tax to be paid?

You may have to fill out form 2210 to show that the conversion happened late in the year and you made your estimated payments at the appropriate time, to avoid an underpayment penalty. It's a pain, especially if you itemize because you need to show the dates of your deductions as well, but you shouldn't be screwed. It's been a few years since I've had to do this but AFAIK the process hasn't changed.

Mostly a terminology nit: I don't think it's the safe harbor provision but rather that unless you specify when you had the taxable event, the IRS assumes it is spread out evenly throughout the year and expects you to pay the taxes in the same quarter as you recognize the taxable income. In fact the safe harbor provision would save you if you had been making quarterly payments equal to your tax liability from last year.

 

[bingybear]

Sorry to be thick.... If I make a sizable tIRA to Roth conversion this month, have not made estimated quarterly payments in Q1-3, my withholdings from payroll are less than the 2018 (due to a partial year of w*rk) - am I screwed by the safe harbor provision even if I make a Q4 payment ahead of the Roth conversion and generously cover the tax to be paid?

I've never had to do this myself, but there is a difference between estimated payments and tax withholding. Estimated payment are seen as paid on the day paid (or received -- not sure exact working of this. Withholding is seen as evenly paid thru the year. This is how employer tax payment work.

Here are my thoughts... when you do a roth conversion you use withholding to pay the taxes (larger distribution that goes to taxes. You then within 60 days deposit back into your TIRA the money from for taxes (I think you can only do this once a year... limitation rolling over where you touch the $. I am making an educated guess that the tax withholding done this way would be considered as being spread thru out the year like employer's tax withholding is.

As I've said I have never tried it.

And even if you pay later than you should... how bad are the penalties?

 

[CRLLS]

Using tIRA money to pay the Roth conversion taxes vs taxable accounts is often said to be a no-no. Sure, you end up with lower balances it the accounts. I personallty don't think it is a loosing situation. At least in most cases. If one looks not to the dollar amount in the account, but to what that dollar amount buys you on the withdrawal end, it is mostly a wash. It could even be a benefit if in a lower tax bracket at the time of conversion. Looking at RMD time, we will definitely be in a higher tax bracket. And when either I or my wife leave this world and the survivor is filing as single, it changes the picture even more so in favor of paying taxes now at the lower or equal tax rate.

Sorry, I have not examples to show. There are too many assumptions and variables to go thru to prove my point.

 

[Kwirk]

DW and I have relatively large amounts in tIRA accounts that we don't expect to use. If the SECURE Act, or something similar, comes to pass our children will be hit with very large tax bills, especially if they have only 5 years to liquidate the inherited IRAs.

Our plan is to do Roth conversions to the top of the 24% bracket (IRMAA be d*mned). Complete conversion may take 15 or more years.

Excess balances in after tax accounts have largely been used up covering taxes for Roth conversions in prior years so we will be paying the taxes mostly from tIRA money. We don't consider this a losing proposition (though it would be nice to have after-tax money for it). I wish we had been converting more aggressively earlier.

Does anybody know for certain if Vanguard will do withholding on Roth conversions? I seem to recall that I couldn't make that happen last year.