Rollover IRA to Roth IRA Transfer

[waynelandry1]

I am retired (75) and have no work related income.  I have a "Rollover" IRA (probably because it was funded via a 401K), a small Roth IRA, a taxable savings account and Social Security.  My accounts are with Schwab.

I would like to begin moving money from the Rollover IRA to my Roth IRA.  I'm used to taking RMDs and withholding taxes at the time of the withdrawal.  My understanding is that I can do the same with the Roth IRA transfer.  I would not, however, want to withhold taxes directly from the Roth money but pay the taxes out of the taxable account.  

I understand that I can set the withholding to 0% when setting up the transfer, and then pay when I file my taxes.  I see a lot of confusing information, however, on possible tax penalties.  It appears that I may trigger a requirement for quarterly tax payments which I definitely don't wan to be bothered with.  Can someone who is familiar with this situation provide any insight as to how I can avoid this problem?

[rjs]

Tax cannot be withheld from a different account than the one you take the distribution from. The solution is to make an estimated tax payment of the amount that you would have had withheld. You can make a one-time estimated tax payment. It does not have to be quarterly.

[waynelandry1]

Thanks for the quick response!

If you'll bear with me, I have some follow up questions:

How do I make an estimated payment?  I assume I would have to do that at the time of the transfer.  Can I do that in my Schwab account?  Or, do I do that through TurboTax or some Federal site?  Also, would 10% suffice (as I do with the RMDs), or do I have to actually try to estimate what the total tax would be?

Thanks!

[VolvoGirl]

You can make an estimated payment from any account that is not in a IRA, 401K or retirement account.  So it would have to be from a personal account like your checking or savings account or a credit card.  

Here are the blank Estimates and instructions…..

http://www.irs.gov/pub/irs-pdf/f1040es.pdf

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.....2025 estimate

[rjs]

You can make an estimated tax payment anytime. It's best to make it around the same time that you do the transfer to avoid being penalized for paying late. (For calculating penalties, withholding is treated as if it was withheld evenly throughout the year, regardless of when it was actually withheld. Estimated tax payments are treated as being made on the actual date of the payment.)

The easiest way to make an estimated tax payment is to use Direct Pay on the IRS web site, to make the payment from a bank account.

We cannot tell you how much to pay. It depends on the amount that you transfer, your other income, and other factors. Any withholding or estimated tax payment is just a deposit towards the total amount of tax you will have to pay for the year. It's not really tied to any specific income. You are always, in effect, estimating your total tax for the year.

[waynelandry1]

Thanks so much!

Wayne

[Opus 17]

There is another option here.  And it is to your advantage, because of how penalties are calculated.

First, remember you must take the RMD from the IRA before you can do any conversion.

Then, do the conversion and have taxes withheld (12-22% in most cases, plus a percentage for the state).  Then you will make up the difference by a separate rollover from the savings account.

For example, suppose you want to convert $10,000.  You could convert $10,000 and then make an estimated tax payment on the IRS web site of $2200.  But instead, suppose you convert $10,000 with 22% withholding.  That will result in $7800 being added to the Roth IRA.  Then, within 60 days after the conversion, you will deposit $2200 from the taxable savings account into the Roth IRA.  It is important that you tell the Roth IRA custodian that this is a rollover/conversion, not a contribution.  The custodian does not need to know or care that this is part of the other conversion, that is up to you to certify when you file your tax return.  Same net $10,000 goes into the Roth IRA, the difference is that the IRS gets $2200 as withholding instead of as an estimated payment.

If you do your conversion in the second half of the year, this is to your advantage because of the different ways that the under-payment penalty is calculated for withheld payments vs estimated payments.  If you make a large conversion and estimated payment late in the year, you will likely be assessed an underpayment penalty unless you include form 2210 with schedule AI (the annualized income method of estimating payments).  Having the taxes withheld and making up the difference avoids this situation.  (I can give you the full technical description if you want.)

It is important, if using this method, that your separate deposit clears in 60 days or less from the direct conversion.  And, you can only use this method once per calendar year.

On the other hand, if you do the conversion in the first quarter of the year (Jan 1-March 31), you can spread out your estimated payment without risk of penalty.   That is, if you convert $10,000 in January without withholding, you can make your estimated payment of $2200 in 4 installments of $550, which are due April 15, June 15, Sept 15 and Jan 15 of the next year.  This would allow you to keep your money in the interest-bearing account as long as possible.  Again, this is because of how the penalties are calculated and I could give you a longer technical explanation if you want. 

[baldietax]

The simplest way to handle this, especially if you plan on this being a regular annual event over time, is to establish a plan to file quarterly estimated taxes and it just becomes part of your annual routine.  If you can pay electronically on irs.gov it's easier than mailing vouchers/checks and you can see record of your payments under you online account.  Just be sure to designate the payment for Estimated Taxes and correct tax year.

If you make a one-time ES payment then you likely have to file Form 2210 Annualized Income method to show the timing and reduce/eliminate the penalty that IRS will assess by default without this method, as they assume that your income was spread out over the year.  The later in the year you pay a one-off ES, the more the IRS will consider you underpaid for earlier in the year.  If your income event occurs earlier in the year you're better off establishing a quarterly payment plan and keep the ES in your savings account until it is due.  With the AI method you have to calculate your AGI/withholding/qualdiv/LTCG for each quarterly period (3/31, 5/31, 8/31 + 12/31 full year return) so it's bunch of extra work to calculate and file this way.

Generally - if you calculate the safe harbor using prior year tax and make quarterly estimated payments (jf needed) to meet that, then you can do a Roth conversion anytime and pay the balance of the tax required when you file.  Sometimes using prior year can be an overpayment in estimated tax due during the year, but is the simplest calculation as the tax amount is known when you file (in time for Q1 ES) and not subject to running tax estimates, but you need to know how much of that safe harbor will be paid thru withholding.

If you plan on starting Roth conversions this year, see if you already meet the safe harbor based on 2024 tax then it's straightforward, or maybe it's a very small penalty to catch up quarterly ES payments, and not worth dealing with Form 2210 AI method, it depends.

See Form 2210 Lines 1-9 which show the safe harbor and penalty calculation, if you try filling this out for your situation I think you'll see how it works out.

https://www.irs.gov/pub/irs-pdf/i2210.pdf

https://www.irs.gov/pub/irs-pdf/f2210.pdf

FAQ on ES - https://www.irs.gov/faqs/estimated-tax

Form 1040-ES - https://www.irs.gov/forms-pubs/about-form-1040-es