tax implications on the conversion of traditional IRA to Roth IRA

[cspyon]

Oh I forgot to ask this one.

Aside from the transfer (or rollover) of $17,000 to Roth IRA, can I still make the new contribution to Roth IRA (I'm eligible for up to $7,000 per year)? 

[VolvoGirl · Accepted solution]

Yes.  The transfer doesn't affect new contributions.  By the way, are you doing the transfer from a Traditional IRA or an employer 401K plan?  That wasn't clear.

[cspyon]

Got it. It's an employer-sponsored tax-deferred annuity plan that I want to roll over to my Roth IRA.

[SLYKTAX]

When I convert $15,000 from my IRA to Roth, $2000 went to tax withholding and $13,000 made it to my ROTH.  I also took $35,000 RMD including Tax withholding.  The 1099R is for both. 

TT tax asked me: Amount converted to ROTH IRA account?

What is the answer?

[VolvoGirl]

Unless you replaced the withholding with your own money then you only converted the 13,000.  The 2,000 withholding becomes a distribution.  

[SLYKTAX]

So the best is to maximized conversion with no tax withholding and pay estimate tax separately, Correct?

[SLYKTAX]

So I should say $13,000 is my Roth conversion as this is the actual number going to my ROTH account.

The $2,000 is a Distribution, taken just to help pay the federal and state taxes.

Correct Madam?

[VolvoGirl]

Yes to both your posts.

[SLYKTAX]

Thank you very much.

I should do no tax withholding and make estimate tax payment separately.  That way I can convert more to ROTH.

By taking a distribution of $2,000 for tax withholding is not a wise move.

Vey good lessons leant.

Thanks again.

[Opus 17]

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@SLYKTAX wrote:

Thank you very much.

I should do no tax withholding and make estimate tax payment separately.  That way I can convert more to ROTH.

By taking a distribution of $2,000 for tax withholding is not a wise move.

Vey good lessons leant.

Thanks again.

---

Not necessarily.  I could go into the detailed rules of why I am making these tips, if necessary, but here are some tips:

1. If you convert in the last quarter of the year, and don't have withholding, you can be hit with an underpayment penalty, even if you make the correct estimated payment on time.  Having withholding avoids this penalty.

2. Once way to make a complete conversion is to add extra money.  You can do this within 60 days and call it a rollover.  For example, you convert $15,000 on December 1 and want to withhold $3000 for taxes.  $12,000 goes into the Roth IRA on December 2.  You have 60 days to deposit $3000 into the Roth IRA from other money (savings account, other investments) and call it a rollover.  Just tell the Roth IRA it is a rollover, they don't need to know or care that it is part of the conversion.  It all works out on your tax return.  Of course, this is assuming you have the money to cover the difference in another account you can pull from.

This is probably the best way to make a late-in-the-year conversion without paying a penalty for under-withholding, as long as you have the separate funds to cover the taxes.  

3. However, if you convert in the first quarter of the year, you have 4 quarters to make estimated payments and not pay a penalty.   For example, you convert $15,000 on February 1 and have no taxes withheld.  You determine that your estimated tax payment should be $3000.  You could pay the full $3000 by the deadline for the first quarter, which is April 15.  Or, you could pay equal quarterly estimates of $750 on April 15, June 15, Sept 15, and Jan 15 of the next year, and you would be considered in compliance with the rules on estimated payments, even though you delayed part of the estimate for almost a year.

I could go into details, but this has to do with how the IRS determines the tax due dates for earnings, withholdings, and estimated payments.  Anyway, the bottom line is that converting late in the year and not having withholding can result in a penalty.  You can avoid this by converting late in the year, having withholding, and depositing the make-up funds as another rollover; or by doing the conversion early in the year.

Cheers. 

[SLYKTAX]

Thanks for the extra details provided that I would never know.

Had I known those tricks, I would have done that. Great lessons I learned from you.

Thanks again.

[SLYKTAX]

Is there a benefit if I do a security (stock) conversion from my IRA to ROTH account instead of using the cash.

conversion?

Is there a time frame that I need to roll outside cash to cover the tax withholding?

[Opus 17]

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@SLYKTAX wrote:

Is there a benefit if I do a security (stock) conversion from my IRA to ROTH account instead of using the cash.

conversion?

Is there a time frame that I need to roll outside cash to cover the tax withholding?

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There is no particular benefit to doing an in-kind transfer, but you won't be able to do the withholding in that case.  That is to say, if you wanted to convert $10,000, and that happened to be 1000 shares of a specific stock you liked at $10 each, you can't have withholding and keep all 1000 shares.  If you wanted $2000 withheld for tax, you could only transfer 800 shares in-kind, and cash out 200 shares for the withholding.  You would have to talk to the broker about the details.

You have 60 days to complete the conversion.  In other words, if you do a Roth conversion of $10,000 on April 1 and have $2000 withheld, you have until May 30 to put another $2000 into the Roth from another source to complete the rollover (conversion).  

[SLYKTAX]

thanks