Old employer 401k rollover to current Roth IRA (large federal tax burden now)

[jayhawkdave]

In December 2020, I rolled over my wife's 401k for over $348,000 from a previous employer and withheld 10% for taxes into her current Roth IRA and now I am being taxed more than $52k for this transaction in addition to the 10% I already took on this transaction.  They sent me a check in her existing Roth IRA's name with the 10% tax taken out already and I bought more shares of the current mutual fund in her already existing Roth IRA.  What can I do to avoid paying the large federal tax burden?  Not sure why I am being taxed so much for this.

Thanks,

Dave

[dmertz]

What can I do to avoid paying the large federal tax burden?

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Unfortunately, there is nothing you can do.  Most if not all of this income is falling well above the 10% tax bracket, likely most if it in the 24% tax bracket, so the $52k balance due seems quite believable.  This amount of tax underpayment is also likely to result in a tax underpayment penalty and, if your wife is not eligible for an exception to the early-distribution penalty and other funds were not substituted to complete the conversion or rollover of the entire gross amount, also to a 10% early-distribution penalty on the portion withheld for taxes.

If you are unable to afford to pay the balance due, you can potentially arrange with the IRS for a payment plan.

[macuser_22]

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@jayhawkdave wrote:

In December 2020, I rolled over my wife's 401k for over $348,000 from a previous employer and withheld 10% for taxes into her current Roth IRA and now I am being taxed more than $52k for this transaction in addition to the 10% I already took on this transaction.  They sent me a check in her existing Roth IRA's name with the 10% tax taken out already and I bought more shares of the current mutual fund in her already existing Roth IRA.  What can I do to avoid paying the large federal tax burden?  Not sure why I am being taxed so much for this.

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The $52K tax on the $348K Roth conversion indicates that you are in the 15% tax bracket so 10% ($34,800) will not be enough to pay the tax.   The 1099-R box 4 amount will go on the 1040 line 25 to offset your total tax liability for all your income.   Looks like you will owe and additional $17,200 in tax that was not withheld.

[jayhawkdave]

@dmertz I was just trying to rollover her existing 401k from a previous employer into an existing Roth IRA that she currently has.  I didn't use the money for anything other than a new investment in an existing Roth IRA.  Would it be the same tax burden if I rolled that money over to a traditional IRA? I have always received a tax refund in the past and I'm 55 now and this is all new to me.  Always used TurboTax...

Thanks,

Dave

[dmertz]

There is no 15% tax bracket.  I have assumed that $52k is the balance due, suggesting that the tax bracket that most of the $348k falls in is about 14% more than the 10% withheld for taxes, in other words, the 24% tax bracket.  It's improbable that itemized deductions would bring the tax liability for most of this income below the 24% tax bracket.

[dmertz]

Would it be the same tax burden if I rolled that money over to a traditional IRA?

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No, not for 2020.  A rollover to a traditional IRA would have been a nontaxable rollover and this income would have been continued to be deferred.  A rollover to a Roth IRA is a taxable rollover.  The advantage of a rollover to a Roth IRA is that any future investment gains are tax-free instead of tax-deferred, once the requirements for qualified Roth IRA distributions are met.  You pay tax now instead of paying more tax later.

[jayhawkdave]

@macuser_22 I wish I just left the money in her old 401k now but I was worried that her previous employer was going  out of business and I wanted control of the money before that happened. You say I should only have to pay an additional $17,200 than why is Turbo Tax saying I owe $52K in addition to the $38k I already I paid?  I'm so confused and stressed with this.

Dave

[VolvoGirl]

Right, you should have rolled it over to a TRADITIONAL IRA not a ROTH.  A Traditional IRA stays tax deferred and the earnings are tax deferred until you take it out.  Then you pay tax on it and on any growth.

You put taxable income into a ROTH.  You don't get a deduction for a ROTH contribution.  You pay tax on it now.  It grows tax free and when you take it out it is all tax free.

[dmertz]

To avoid having spiked your marginal tax rate, it probably would have been better to convert to Roth over several years rather than all at once, but it's too late to do anything about that now.  A rollover from the traditional account in the 401(k) to the Roth IRA is irrevocable.

[macuser_22]

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@jayhawkdave wrote:

@macuser_22 I wish I just left the money in her old 401k now but I was worried that her previous employer was going  out of business and I wanted control of the money before that happened. You say I should only have to pay an additional $17,200 than why is Turbo Tax saying I owe $52K in addition to the $38k I already I paid?  I'm so confused and stressed with this.

Dave

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See @dmertz answer above.  I was assuming that the tax on the 1040 line 5b was $52K which is 14.9% of the $348K.  If you are being taxed at the 24% tax rate then  the total tax would be about $83,5200+ (on 1040 line 5b) minus the $38K already paid leaves about $45,520 additional tax on the conversion.  (Your actual tax depends on your total taxable income.)