So, I know that converting my traditional IRA to a ROTH will count as income because it’s not money I put into it this year. I’ve checked that it won’t affect my tax bracket or my deductions. How do I handle withholding to keep from paying a huge tax bill on money not going in my pocket? Does the company who I work with for my IRA withhold an estimated tax? Or just the estimated “early retirement” penalty? Should I ask them to withhold anything or would that make my taxes worse??
You can request to have any amount of the distribution to be withheld to pay the tax, but that will also be part of the taxable distribution and it is less money to put in the Roth. It is best to convert all the money and keep it growing in an IRA if possible, if you have other funds to pay the tax with. You can pay it as estimated tax using other funds.
IRA distributions are taxed a ordinary income just like W-2's at your margional tax rate. You can get a rough estimate using the "TaxCaster" tool https://turbotax.intuit.com/tax-tools/calculators/taxcaster/
The conversion will be taxable at your tax rate and may push you into a higher tax bracket. You should send in an estimated payment on form 1040ES to cover the tax. Maybe like 10 or 12% etc. And don't forget your state.
Or you can pay directly on the IRS website https://www.irs.gov/payments
Be sure to pick the right kind of payment and year.....2021 Estimate
Let’s suppose you want to convert $10,000. If you withdrew $10,000 and had the custodian withhold 20% for taxes, then you would end up only converting $8000, and the other $2000 counts as a regular distribution. If you are under age 59 1/2, that’s subject to an additional 10% penalty tax.
If you can afford to take the $2000 in taxes from other funds that you have, you would convert the entire $10,000 without the first trustee withholding anything. You can make a estimated tax payment on your own using the IRS website www.irs.gov/payments.
Depending on your tax bracket, the conversion may cost 12%, 22%, or 24% in federal taxes (for most people). You can also expect to pay between 3% and 10% in state taxes, depending on which state you live in and what your income level is.
Also note that in some circumstances, the conversion can have repercussions in other areas of your tax life. For example, depending on your age and life situation, raising your income with a Roth conversion might disqualify you from claiming the American opportunity credit for college tuition that you pay for a dependent child, or it may reduce your eligibility for the child tax credit, or it may increase the taxability of your Social Security.
Also the ENTIRE IRA doesn't have to be converted all at once in one tax year ... if you time it right you can minimize the amount of taxes you pay all together. Sit down with a tax and/or financial planner to see what suits you best. If you are over the age of 60 then making the conversion may or may not be a wise choice so taking your entire financial story into consideration is the right thing to do... think on this before making any moves.