Roth conversion to pay Income Tax

[bada bing]

I'm getting ready to make my annual Roth conversion tomorrow.
I also may have not paid enough estimated taxes to cover my required withholding on total income for 2022, as I had some lumpy income and was lazy/distracted. I know that tax withholding from a Roth conversion count as paid on time for general withholding, so I can bump up the voluntary conversion withholding to cover my anticipated total withholding requirement. My question is: Can I recompensate from taxable money outside retirement accounts to my Roth IRA for the amount diverted from the conversion for taxes ? I believe I read something about doing this in the last few years, but my Google search isn't bringing up the relevant info. The reason for doing this is to avoid potential late/underpayment of estimated taxes.

Anyone know ?

 

[OldShooter]

You don't necessarily have to have paid enough to cover your 2022 income tax as long as you have paid the safe harbor amount: 100% or 110% of your 2021 tax. https://www.hrblock.com/tax-center/irs/tax-responsibilities/avoiding-underpayment-tax-penalty/

 

[Exchme]

I am not a lawyer, but have never heard of it, surely somebody would have thought of that by now. I believe your contribution to your Roth from taxable would be an excess contribution and would be subject to a 6% penalty each year until it is corrected.

 

[MarieIG]

There was a recent thread on something like this using the 60 day rollover.

https://www.early-retirement.org/fo...catchup-withholding-and-penalties-116242.html (more info starting at post #29 and Gumby's link thereafter).

See, also:

https://www.irs.gov/pub/irs-tege/rollover_chart.pdf

 

[Gumby]

Yes, you would put the money paid in taxes back in your taxable IRA, not into your Roth.

 

[bada bing]

Yes, you would put the money paid in taxes back in your taxable IRA, not into your Roth.

Yes, thank you. The recent thread on this went unnoticed by me until today. I read it and it refreshed my memory. I was sort of hoping I could put the withheld tax into the Roth, rather than the taxable, but I can see why that's probably a no go. I'll be doing a withholding withdrawal round trip from my IRA this week. I'll post any snafus in the other thread, should they happen.

There ought to be a cute name assigned to this maneuver, like the "backdoor Roth". I propose "IRA withholding boomerang" as a potential name.

 

[audreyh1]

Why would anyone pay taxes out of their Roth conversion or try to use a Roth conversion to pay income taxes via withholding (thus not in fact converting those funds to their Roth but also increasing their taxable income)? I just don't get it.

If you really want to do a Roth conversion, but don't have the funds in non-tax-deferred accounts to pay the taxes by the deadlines, maybe. But it's still unfortunate not to convert all to a Roth.

 

[Exchme]

Why would anyone pay taxes out of their Roth conversion or try to use a Roth conversion to pay income taxes via withholding (thus not in fact converting those funds to their Roth but also increasing their taxable income)? I just don't get it.

If you really want to do a Roth conversion, but don't have the funds in non-tax-deferred account sto pay the taxes by the deadlines, maybe. But it's still unfortunate not to convert all to a Roth.

He's trying to do withholding from his Roth Conversion to avoid late penalties since withholding is deemed to be timely by the IRS, whereas estimated tax payments are credited in the quarter they are paid. Then he wants to pretend he didn't use the IRA money for withholding and fill the Roth from taxable. It sounds completely illegal to me.

 

[Romer]

Why would anyone pay taxes out of their Roth conversion or try to use a Roth conversion to pay income taxes via withholding (thus not in fact converting those funds to their Roth but also increasing their taxable income)? I just don't get it.

If you really want to do a Roth conversion, but don't have the funds in non-tax-deferred accounts to pay the taxes by the deadlines, maybe. But it's still unfortunate not to convert all to a Roth.

I see your point, but don't have the same view. I am converting IRA to ROTH to a certain limit.
1) Pay lower tax rates now than in 2026
2) Reduce taxable income so when I kick the bucket, my wife is still in the lower tax bracket
3) Eliminate RMDs - not a big driver

Right now while the market is down I see it as a good time to do conversions. I understand the tax paid would have grown.

For 2023 since I will be only 62 I plan to maximize my Roth Conversions to the 24% bracket and have the cash to pay 80% of the taxes. This gives me until Jan 15 2024 to withdraw IRA funds to pay that final tax quarterly bill. I am planning on end of 2023 to make 2024 cleaner so leaving headroom to do that with hopefully a much better market in a year than we have today

Then for 2024 and 2025 will stay within 22% bracket for Medicare income limits and the average tax rate for conversion will be ~18%

In 2026 I may be starting SS (65) and tax rates May have gone up and the market may have recovered or tanked more, so I will step back and relook at the approach for 2026+

The Married vs Single Tax rates is my primary driver. If I convert to my plan, then my wife even at single rates will be in the 12/15% tax bracket vs the 25% bracket for the income she will need. It may even fall into the 10% bracket depending on STD deduction and SS rules limits for taxable at that time. The wrinkle here that is her aging parents are going to leave her a lot (she is the executor) and a lot of it is still in their IRAS with RMDs ongoing. I don't want that to drive us or her into the 32% tax bracket. I know more money with higher taxes isn't a bad problem.

Even doing those conversions and paying the tax, we will have funds well into our 100's if we both are still on the right side of the grass.

I do see your perspective. I have a different set of variables I am considering and prioritizing.

I am sure there are many other opinions and others will be happy to share their perspective. I actually look forward to that hoping I learn something I hadn't thought of. Polite respectful discussion with differing opinions is a great learning source here.

 

[audreyh1]

Well sounds like you really have a plan figured out.

 

[NW-Bound]

Why would anyone pay taxes out of their Roth conversion or try to use a Roth conversion to pay income taxes via withholding (thus not in fact converting those funds to their Roth but also increasing their taxable income)? I just don't get it.

If you really want to do a Roth conversion, but don't have the funds in non-tax-deferred accounts to pay the taxes by the deadlines, maybe. But it's still unfortunate not to convert all to a Roth.

Yes, someone may be unfortunate in that he has a lot more assets in tax-deferred accounts than in after-tax accounts. Like 3x more.

When that happens, it limits his options.

 

[MarieIG]

Yes, someone may be unfortunate in that he has a lot more assets in tax-deferred accounts than in after-tax accounts. Like 3x more.

When that happens, it limits his options.

Perhaps discuss with someone using his skills to earn some of that premium income inside a Roth account. . .

 

[SevenUp]

I was sort of hoping I could put the withheld tax into the Roth, rather than the taxable, but I can see why that's probably a no go.

Why do you think that you can't put the amount of the withheld tax into the Roth, at least within 60 days of the withdrawal from the tIRA?

 

[NW-Bound]

Perhaps discuss with someone using his skills to earn some of that premium income inside a Roth account. . .

My income was too high to be allowed Roth contribution when I was working. I have been doing some Roth conversion, but our Roth accounts are still nothing compared to the 401k/IRA. And while waiting till 59-1/2 to get access to the tax-deferred accounts, I drained our after-tax accounts to the tune of $100K/year. College tuition and stuff.

And that's why our tax-deferred accounts dwarf the other 2 types. Plus, I have accumulated $1M in option premium in these accounts in the last 3 years. Time to pay taxes to get that money outa there. You can't spend it until you pay taxes on it.

Yes, imagine if my Roth is the same size as my tax-deferred. Imagine $1M gain from option premium free of tax. Small money for truly rich people, but for me I can't spend that much.

 

[NW-Bound]

Well, maybe sacrificing some after-tax money to get more into Roth is a better deal.

I dunno. Having too much money stuck inside tax-deferred accounts is like people in California with homes that are expensive. OK, you feel rich, but what good is the money that you cannot get at?

 

[donheff]

Why would anyone pay taxes out of their Roth conversion or try to use a Roth conversion to pay income taxes via withholding (thus not in fact converting those funds to their Roth but also increasing their taxable income)? I just don't get it.

If you really want to do a Roth conversion, but don't have the funds in non-tax-deferred accounts to pay the taxes by the deadlines, maybe. But it's still unfortunate not to convert all to a Roth.

It can be a very complicated equation. I used Pralana Gold to evaluate Roth conversions with taxes from taxable vs taxes from an IRA (with the iterations of additional taxes on the withdrawals to pay those taxes). The CGs in taxable are high and the state tax rate for CGs in taxable is the same as for earned income. The estate will go to the kids, so I had to model the tax hit of the IRAs over 10 years vs a larger untaxed taxable adjusted to market rate and continued Roth earnings for 10 years. And, since there is an estate tax in DC, I had to model the impact of the larger estate. I was surprised to find that it was turning out to be a wash to pay taxes from the IRAs and even appeared to be beneficial for my son who will likely be in a high tax bracket when we die and thus heavily impacted by the need to liquidate those larger tIRAs.

That all said, Pralana Gold is a bit of a black box to me so I worry that I am missing something. I have not found any CPAs or FAs who seem both interested and competent to effectively analyze the factors at play. I suspect the people who could do it are some of the former engineers on this board, but I am not sharing those kinds of detailed financials with "some guy on the Internet."

 

[NW-Bound]

^^^ One wonders how many man-hours are wasted by Americans each year trying to optimize their taxes.

Are taxes this complex in other developed countries? I am sure poorer countries do not have this complex tax system; very few pay anything.

 

[donheff]

^^^ One wonders how many man-hours are wasted by Americans each year trying to optimize their taxes.

Are taxes this complex in other developed countries? I am sure poorer countries do not have this complex tax system; very few pay anything.

It is ridiculous but I don't see any likelihood of simplification on the horizon.

 

[mebden]

Does anybody have the taxes withheld from the traditional IRA say at Fidelity that is being converted to a Fidelity Roth Ira? I know it lowers the amount going to the Roth but at least taxes are already taken out for the conversion, and then you don't have to pay the taxes out of your savings?

 

[audreyh1]

You want to be 59 1/2 or older to avoid the 10% penalty for IRA withdrawal since the tax portion wasn’t converted to the Roth. It may be withheld for taxes, but it still counts as a withdrawal.

 

[mebden]

You want to be 59 1/2 or older to avoid the 10% penalty for IRA withdrawal since the tax portion wasn’t converted to the Roth. It may be withheld for taxes, but it still counts as a withdrawal.

audreyh1 you still get penalized 10% if under 59 1/2 even if its all being done with 1 company like Fidelity just changing from the IRA to Roth? I guess I never thought of that

 

[Gumby]

You want to be 59 1/2 or older to avoid the 10% penalty for IRA withdrawal since the tax portion wasn’t converted to the Roth. It may be withheld for taxes, but it still counts as a withdrawal.

But if the tax portion was put back in the tIRA within 60 days (by taking money from after tax accounts), wouldn't that be an indirect rollover and be free of the penalty?

The way I look at it is this: Suppose I make a $20k Roth conversion (from tIRA to Roth). Separately, I make a $7k - $8k tIRA withdrawal and have it all withheld for taxes to cover the Roth conversion (or maybe a little more to cover some other taxes due.) Within 60 days, I deposit $7k-$8k into my tIRA, by taking it from my taxable account. That's an indirect rollover. So, now I have managed to pay all my taxes and avoid an underpayment penalty, because the withholding is considered to be withheld evenly over the year. I have effectively paid the taxes out of after tax money, and I have preserved $7k-$8k in my tIRA that I can Roth convert next year. And I should not have to pay an early withdrawal penalty.

If I am mistaken in this view, I welcome correction.

 

[Out-to-Lunch]

But if the tax portion was put back in the tIRA within 60 days (by taking money from after tax accounts), wouldn't that be an indirect rollover and be free of the penalty?

The way I look at it is this: Suppose I make a $20k Roth conversion (from tIRA to Roth). Separately, I make a $7k - $8k tIRA withdrawal and have it all withheld for taxes to cover the Roth conversion (or maybe a little more to cover some other taxes due.) Within 60 days, I deposit $7k-$8k into my tIRA, by taking it from my taxable account. That's an indirect rollover. So, now I have managed to pay all my taxes and avoid an underpayment penalty, because the withholding is considered to be withheld evenly over the year. I have effectively paid the taxes out of after tax money, and I have preserved $7k-$8k in my tIRA that I can Roth convert next year. And I should not have to pay an early withdrawal penalty.

If I am mistaken in this view, I welcome correction.

I'm not Audrey, but I believe she was responding to mebden, who was explicitly considering using the withdrawn funds to pay taxes.

I believe your explanation is indeed correct for those who are looking to pay for taxes from their taxable account.

 

[TheWizard]

When I do an end of year Roth conversion, I just do a single fourth quarter estimated tax payment via EFTPS.
It works for me...

 

[MarieIG]

My income was too high to be allowed Roth contribution when I was working. I have been doing some Roth conversion, but our Roth accounts are still nothing compared to the 401k/IRA. And while waiting till 59-1/2 to get access to the tax-deferred accounts, I drained our after-tax accounts to the tune of $100K/year. College tuition and stuff.

And that's why our tax-deferred accounts dwarf the other 2 types. Plus, I have accumulated $1M in option premium in these accounts in the last 3 years. Time to pay taxes to get that money outa there. You can't spend it until you pay taxes on it.

Yes, imagine if my Roth is the same size as my tax-deferred. Imagine $1M gain from option premium free of tax. Small money for truly rich people, but for me I can't spend that much.

Yes, I get it. I live in a HCOL area, had six expensive kids, and also earned too much for Roth contributions. (I did not know about conversions until after I started lurking on this forum, and learned that they were prorata, after my IRA was mostly growth. )

Yes, I can imagine that - and would like to "see" that happen to you. (I don't have your skills, but I can appreciate another's talent.)

But your traditional IRA is going to grow to be a beast. Perhaps take a bit more medicine now, and exercise your talents in the Roth . . .