Traditional 401k to ROTH IRA conversion

martiansoldier · ‎February 9, 2021

In 2020, I moved some of my old 401K funds to a ROTH IRA account and in the process, I requested my 401K custodian to withhold 15% of the converted amount as taxes, which they did. For example, let's say, I withdrew a total of $11,764.71 of which $10,000 went to my ROTH IRA and $1,764.71 was used to pay taxes.

Now, I have received 2 separate 1099-R forms from the custodian, one showing the conversion amount (say $10,000) in boxes 1 and 2a along with Code G in box 7 and the other showing the amount of withheld taxes (say $1,764.71) in boxes 1, 2a and 4 along with Code 1 in box 7. In both cases, IRA/SEP/SIMPLE is unchecked.

Upon entering the 1099-R form for the amount of withheld taxes ($1,764.71) into Turbotax Premier 2020, my refund reduces by 10% of the withheld taxes or in the amount of, say $176 as Turbo Tax treats the taxes as money withdrawn but not necessarily as withheld taxes for the conversion amount. My understanding is that the I pay taxes for the whole withdrawal amount (say $11,764.71) based on the rate for my income bracket but no penalty as I am not pulling this money out early for other purposes.

What am I missing here?

ThomasM125 · ‎February 9, 2021

The full amount of the distribution, $11,764.71 would be taxable even though some of it was paid to the government for your withholding. The portion used for the withholding did not get rolled over, so it would be subject to an early withdrawal penalty if you are not at retirement age.

It is as if you withdrew pension funds prematurely and then turned around and paid them is as estimated taxes.

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dmertz · ‎February 9, 2021

The code 1 on the Form 1099-R showing the portion withheld for taxes indicates that you were under age 59½ at the time of this distribution, so TurboTax is correctly applying the 10% early-distribution penalty to this portion and ThomasM125 said. With $1,764.71 of the distribution not being rolled over, that penalty is $176.

To avoid the $1,764.71 being subject to this penalty you would have to claim a valid penalty exception of Form 5329. However, you haven't mentioned anything that would qualify you to claim such an exception. In addition to the usual penalty exceptions for distributions from a 401(k) (https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distri...), you could also avoid the penalty if you qualified to receive a coronavirus-related distribution (CRD). Claiming this as a CRD, if eligible, would also allow you to spread the $1,764.71 of taxable income over 2020, 2021 and 2022 in equal parts.

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martiansoldier · ‎February 9, 2021

Thank you for the response. If my understanding of your response is correct, although the $1764.71 was withheld for taxes and paid to the IRS, I still incur a 10% penalty since it was not rolled over to the ROTH IRA. Instead, had I decided rollover the whole $11,764.71 to ROTH and pay these taxes out of pocket and not as part of the distribution, I wouldn't have to worry about having to pay the 10% penalty...correct?

I will have to look further into the Form 5329 and CRD eligibility. Thanks again!

dmertz · ‎February 9, 2021

Correct. Paying the taxes with other money also maximizes the amount that ends up in the Roth IRA on which there can be future tax-free growth.

Traditional 401k to ROTH IRA conversion

Retirement tax questions

Retirement tax questions

Retirement tax questions

Retirement tax questions