Author Topic: Roth conversion questions  (Read 1010 times)

Highbeam

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Roth conversion questions
« on: July 06, 2020, 10:54:04 AM »
I want to convert to my existing roth IRA about 85k of traditional rollover IRA at vanguard, the whole account. This will trigger income tax on that 85k (almost all at 22%) but I can’t pay the income tax from the converted funds because that would be a distribution prior to age 59.5 and trigger a 10% penalty since I'm 43. This means I have to pay that income tax some other way. It will be like 20,000 bucks and I think I want vanguard to send in the money.

1)   I can sell VTSAX from my taxable account to pay the tax bill and generate even more income tax.
2)   I can maybe ask vanguard to bill my checking account like a regular purchase for the tax bill.
3)   Since I got a tax refund last year, maybe owe 20k this year at tax time. I’ll get to keep that money longer where it can earn me something.

Is there another choice? What would you do? One more question, I don’t think it does but does this count against my normal 6,000$ annual roth contribution limits?

EvenSteven

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Re: Roth conversion questions
« Reply #1 on: July 06, 2020, 11:10:01 AM »
I want to convert to my existing roth IRA about 85k of traditional rollover IRA at vanguard, the whole account. This will trigger income tax on that 85k (almost all at 22%) but I can’t pay the income tax from the converted funds because that would be a distribution prior to age 59.5 and trigger a 10% penalty since I'm 43. This means I have to pay that income tax some other way. It will be like 20,000 bucks and I think I want vanguard to send in the money.

1)   I can sell VTSAX from my taxable account to pay the tax bill and generate even more income tax.
2)   I can maybe ask vanguard to bill my checking account like a regular purchase for the tax bill.
3)   Since I got a tax refund last year, maybe owe 20k this year at tax time. I’ll get to keep that money longer where it can earn me something.

Is there another choice? What would you do? One more question, I don’t think it does but does this count against my normal 6,000$ annual roth contribution limits?

I'm unsure whether or not you can have vanguard pay the taxes in this. I would go with the bolded, but make sure you are adjusting your withholdings to make sure you don't get hit with a penalty for underpayment of taxes.

Do you file married joint, and not including this conversion have about 80k in taxable income? If not, it might be worth it to break this into a couple years.

Conversions do not count against contribution limits.

Highbeam

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Re: Roth conversion questions
« Reply #2 on: July 06, 2020, 11:19:53 AM »
I want to convert to my existing roth IRA about 85k of traditional rollover IRA at vanguard, the whole account. This will trigger income tax on that 85k (almost all at 22%) but I can’t pay the income tax from the converted funds because that would be a distribution prior to age 59.5 and trigger a 10% penalty since I'm 43. This means I have to pay that income tax some other way. It will be like 20,000 bucks and I think I want vanguard to send in the money.

1)   I can sell VTSAX from my taxable account to pay the tax bill and generate even more income tax.
2)   I can maybe ask vanguard to bill my checking account like a regular purchase for the tax bill.
3)   Since I got a tax refund last year, maybe owe 20k this year at tax time. I’ll get to keep that money longer where it can earn me something.

Is there another choice? What would you do? One more question, I don’t think it does but does this count against my normal 6,000$ annual roth contribution limits?

I'm unsure whether or not you can have vanguard pay the taxes in this. I would go with the bolded, but make sure you are adjusting your withholdings to make sure you don't get hit with a penalty for underpayment of taxes.

Do you file married joint, and not including this conversion have about 80k in taxable income? If not, it might be worth it to break this into a couple years.

Conversions do not count against contribution limits.

I file MFJ and my AGI was in the 80s last year after all of the deductions for 457s and HSA. I don't mind a slight drift into the 24% bracket to get it all over and done with in one shot.

Since I got a refund last year for 2019 and have left my withholdings alone this year, am I not protected from a penalty from underpayment for 2020 taxes?

EvenSteven

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Re: Roth conversion questions
« Reply #3 on: July 06, 2020, 11:28:37 AM »
I want to convert to my existing roth IRA about 85k of traditional rollover IRA at vanguard, the whole account. This will trigger income tax on that 85k (almost all at 22%) but I can’t pay the income tax from the converted funds because that would be a distribution prior to age 59.5 and trigger a 10% penalty since I'm 43. This means I have to pay that income tax some other way. It will be like 20,000 bucks and I think I want vanguard to send in the money.

1)   I can sell VTSAX from my taxable account to pay the tax bill and generate even more income tax.
2)   I can maybe ask vanguard to bill my checking account like a regular purchase for the tax bill.
3)   Since I got a tax refund last year, maybe owe 20k this year at tax time. I’ll get to keep that money longer where it can earn me something.

Is there another choice? What would you do? One more question, I don’t think it does but does this count against my normal 6,000$ annual roth contribution limits?

I'm unsure whether or not you can have vanguard pay the taxes in this. I would go with the bolded, but make sure you are adjusting your withholdings to make sure you don't get hit with a penalty for underpayment of taxes.

Do you file married joint, and not including this conversion have about 80k in taxable income? If not, it might be worth it to break this into a couple years.

Conversions do not count against contribution limits.

I file MFJ and my AGI was in the 80s last year after all of the deductions for 457s and HSA. I don't mind a slight drift into the 24% bracket to get it all over and done with in one shot.

Since I got a refund last year for 2019 and have left my withholdings alone this year, am I not protected from a penalty from underpayment for 2020 taxes?

The safe harbor rule that I am familiar with for underpayment is:

"Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller. "

So if this year, you pay at least the amount that you paid last year, you should be OK. I would double check to make sure that you are really paying 100% of what you did last year.

Highbeam

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Re: Roth conversion questions
« Reply #4 on: July 06, 2020, 11:38:20 AM »
Thank you EvenSteven. I will verify that my 2020 W2 withholdings are equal to or greater than 2019.

Ideally I would have done this conversion when markets were way down but I didn't. 

MDM

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Re: Roth conversion questions
« Reply #5 on: July 06, 2020, 11:41:36 AM »
Since I got a refund last year for 2019 and have left my withholdings alone this year, am I not protected from a penalty from underpayment for 2020 taxes?
The safe harbor rule that I am familiar with for underpayment is:

"Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller. "

So if this year, you pay at least the amount that you paid last year, you should be OK. I would double check to make sure that you are really paying 100% of what you did last year.
+1 on the double check.

The 2019 refund suggests, but does not guarantee, there will not be a 2020 underpayment penalty.  Should be easy enough to compare expected 2020 withholding to 2019 tax liability (not 2019 withholding) to verify.

seattlecyclone

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Re: Roth conversion questions
« Reply #6 on: July 06, 2020, 11:44:11 AM »
I'm curious why you want to run your tax payment through Vanguard. Why not pay the IRS directly from your checking account? I'm not sure how you would go about asking Vanguard to pay tax on your behalf unless it's part of the standard withholding they might have to do from one of your transactions with them. You already stated you don't want anything withheld from the conversion transaction and they generally don't have to do any withholding from brokerage transactions.

I agree that you should learn more about the safe harbor rule. It's likely you will be just fine waiting to pay this extra tax until your taxes are due in the spring. You can save up from your paychecks to do this, or sell some taxable stock at that time.

Highbeam

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Re: Roth conversion questions
« Reply #7 on: July 06, 2020, 12:46:45 PM »
All done. Following the advice here. It was easy, so easy.

Vanguard asked if I wanted a withholding made, minimum 10%, but I elected no withholding. I was wrongfully under the impression that the tax payment should be made immediately in the same way that you aren't allowed to just pay all of your income tax every year in a lump sum. So vanguard did a 100% conversion to Roth. No penalty on underage withdrawal to pay the income tax from the converted amount.

I will owe federal income tax on all of that conversion. I will pay it from my checking account in April 2021 when I submit my 2020 taxes. Gives me time to save up from what would normally be money sent to my taxable accounts.

Last year I got a tax refund and I have verified that my 2020 withholdings will exceed the 2019 tax liability which means I will be in safe harbor.

I will also make for dang sure that I'm withholding enough on my 2021 income to not have to pay the IRS in April of 2022 since there will be no safe harbor.



MDM

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Re: Roth conversion questions
« Reply #8 on: July 06, 2020, 01:16:16 PM »
I will also make for dang sure that I'm withholding enough on my 2021 income to not have to pay the IRS in April of 2022 since there will be no safe harbor.
As long as you withhold at least 90% of the tax liability, and have the funds available in April, there is no problem owing then.  Not that it will make or break your overall net worth, but getting some interest yourself rather than giving the IRS an interest-free loan until you get a refund is a good thing.

Highbeam

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Re: Roth conversion questions
« Reply #9 on: July 06, 2020, 02:01:50 PM »
Thanks again folks. This rollover IRA was from my first job fresh out of school where we had a 401k available. It's a bit nostalgic and sad to see the account dissolved. Bring on the tax free earnings!

BTDretire

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Re: Roth conversion questions
« Reply #10 on: July 25, 2020, 07:39:48 AM »
Thanks again folks. This rollover IRA was from my first job fresh out of school where we had a 401k available. It's a bit nostalgic and sad to see the account dissolved. Bring on the tax free earnings!
I'm curious why you wanted to do it all in one year? If you did less for a few years, could you have stayed in the 12% bracket?