Question on basis for my first roth ira ladder conversion

[Fire1018]

I'm a newbie at the actual mechanics of FIRE, so I'm hoping to get some advice from @seattlecyclone or some of the other more experienced FIREE's here.

I am in my first year of FIRE and have just completed a conversion to start my roth IRA ladder.  Because this was my first conversion, I performed it over the phone to ask questions.  I converted $78K, 10% was withheld for federal taxes and 4% was withheld for state taxes.  When the transaction was complete, I asked the representative if I would be able to withdraw the $78K tax free in 5 years and he stated that I would only be able to withdraw the $67K that was left after the tax withholdings as basis.

All of the articles I have read just said something like "convert $50k now and you can withdraw $50K tax free in 5 years".

So in 5 years can I withdraw $78K or only $67K?

Do people generally pay the taxes from a separate account instead of having them automatically withheld so they would get the full $78K of basis?

Thanks for the help!

[seattlecyclone]

Having 10% withheld was probably a mistake. This transaction is treated the same as if you converted 86% of your $78k to your Roth account and withdrew the other 14% straight to your checking account (forwarding 10% to the IRS and 4% to your state). You'll therefore owe the 10% early withdrawal tax on the amount that was withheld for taxes, and it won't count toward the Roth IRA basis that you'll be able to withdraw for free in five years.

Next time opt out of the withholding directly from the conversion transaction and pay the taxes separately.

[MDM]

...have just completed a conversion to start my roth IRA ladder.

If you want to have the full conversion amount in the Roth IRA - and particularly if you are under age 59.5 and want to avoid the 10% early distribution penalty - and have the cash available to do so, you can use The 60-Day Rollover Rule for Retirement Plans if you haven't done another indirect rollover within the past year.

Make sure the Roth custodian understands that this is a "rollover contribution" so it gets reported correctly to the IRS.  See Will 60-Day Roth Rollover fix withholding? - Bogleheads.org.

If you do all the above,
- $78K will be withdrawable tax and penalty-free on 1-Jan-2028
- you will not owe the 10% early distribution penalty
- the $7800 federal and $3210 state withholding amounts will still count when you file your 2023 tax return

[Fire1018]

Having 10% withheld was probably a mistake.

This was definitely a mistake for me!  Thanks for taking the time to explain it to me and thanks MDM for showing me how to fix it!  Apparently, all I need to do is send in a check and earmark it as a 60 day rollover contribution to avoid the 10% early withdrawal penalty on the money originally withheld for taxes.  I'm still trying to decide if I should just pay the penalty or jump through some hoops moving money around to pay the taxes.  Luckily I have 60 days to complete the rollover so I have a little bit of time to fix things.  Next time I'll be sure to have enough cash on hand to pay all the taxes separately before performing my roth conversion.

Hopefully this post will help out some other first timers and prevent them from making the same mistake as I did!

[reeshau]

Next time I'll be sure to have enough cash on hand to pay all the taxes separately before performing my roth conversion.

If you usually get a tax refund, or you have non-refundable credits that you don't use, then you don't even need a check--just tell them not to withhold.

Doing so, and significantly underestimating the taxes you will owe, could result in penalties come April 15, because you under-withheld.  But if you know your situation well enough, you can breeze through this step.

I am FIRE'd, living off long-term capital gains from my taxable account, with ACA subsidies, and 1 kid.  I am doing Roth rollovers at the end of the year to balance / consume my tax credits, since most of my income is taxed at 0%.  I buy tax software as soon as it's available (Nov 4 this year) and do a pro-forma return.  Then I roll over the amount that leaves me at or close to a zero balance.

[secondcor521]

Then I roll over the amount that leaves me at or close to a zero balance.

I did that the first year or two I was FIREd.

Now I think it is better to Roth convert even more.  Yes, I'll pay some taxes, but it could be at a low-ish rate of maybe 15-20% vs. 25% or more later at RMD + SS time.

Although I had a few years where my tax situation was similar to yours and I went from 0% marginal federal tax rate (due to tax credits) to a marginal rate of something horrific due to 10% income tax plus 15% capital gains tax plus 15% ACA subsidy loss plus FAFSA EFC loss which was about 8% or so.  It did make it easy to figure out the AGI at which to stop Roth conversions.

Anyway, suggest you check to see if Roth converting some more might be able to be done at a low-ish but still attractive rate.

[reeshau]

Anyway, suggest you check to see if Roth converting some more might be able to be done at a low-ish but still attractive rate.

Yeah, that's a perfectly rational way to do it, too.  At this point, I don't think the RMD monster will be a big thing for me, so I'm not in a terrible hurry.  I admit I also like the novelty of no estimated tax payments.  But I am keeping a watch on it.  My overall portfolio is about 1/3 each taxable, trad IRA, and Roth.

[secondcor521]

Anyway, suggest you check to see if Roth converting some more might be able to be done at a low-ish but still attractive rate.

Yeah, that's a perfectly rational way to do it, too.  At this point, I don't think the RMD monster will be a big thing for me, so I'm not in a terrible hurry.  I admit I also like the novelty of no estimated tax payments.  But I am keeping a watch on it.  My overall portfolio is about 1/3 each taxable, trad IRA, and Roth.

Makes sense.  It sounds like I'm older than you and my ratio is tilted more towards traditional IRA.