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I will be converting a large Traditional IRA to a Roth IRA this year.
The reasons why I am converting the whole amount are complex and I don't want to get into them here (yet).
When I do this, I will owe income taxes of about 1/3 of the amount of the account.
I intend to not pay any estimated tax on the conversion. I know this results in a "penalty". It is not really a penalty, just the interest on the money I should have paid. I estimate that to be about 1.8% of the tax.
The reasons for not paying an estimated tax are complex and I don't wish to get into them here (yet).
I mentioned this to a tax preparer and he said I should pay the estimated tax at the time of the conversion.
Here is his reasoning:
"Example 1 if you don't have money withheld from the conversion. Roth rules are that you need to keep the conversion in the account for 5 years. If you withdraw in the 5 years you would pay tax on any gains.
On April 15, 2025 you owe 1/3 of the account in taxes now so you use the funds that were converted to pay the taxes. It is now labeled an early distribution, but you still will not pay an early withdrawal penalty because your basis is 3 times what you withdraw. After you pay your taxes your basis is 67% of what was converted.
Example 2. You have money withheld.
1. it does not count as a withdrawal.
2. Basis will stay the same.
I just figured you are going to pay the taxes no matter what, and this gives you a better tax basis"
I don't understand all that but a couple things to add. If you are younger than 59 1/2 there's more issues. Secondly, as I understand it, you pay taxes on the earnings in the Roth if you withdraw in the first 5 years. Which means if you don't need the whole amount within 5 years you may be just withdrawing only principal. Also regarding paying penalty due to no estimated tax depends on timing. If you make the conversation in the last segment of the year, when you file you can pay estimated tax by (I think) jan 15 of the next year to avoid penalty. There is a rather complicated form you have to file to show your income was uneven during the year and only jumped in the last quarter to require estimated tax.
If you're past 59.5, there's no penalty for withdrawing from a Roth in less than five years. Provided the Roth account you withdraw from has been in existence for at least 5 years.
I don't understand all that but a couple things to add. If you are younger than 59 1/2 there's more issues. Secondly, as I understand it, you pay taxes on the earnings in the Roth if you withdraw in the first 5 years. Which means if you don't need the whole amount within 5 years you may be just withdrawing only principal. Also regarding paying penalty due to no estimated tax depends on timing. If you make the conversation in the last segment of the year, when you file you can pay estimated tax by (I think) jan 15 of the next year to avoid penalty. There is a rather complicated form you have to file to show your income was uneven during the year and only jumped in the last quarter to require estimated tax.
Good luck....
(1) I am 76 years old.
(2) I doubt I will need more then the amount I convert within 5 years.
(3) As for delaying the conversion, I have a philosophy regarding estimated taxes which I will explain in a later post, in a few days I hope. But you are correct that a conversion late in the year won't trigger a penalty. I would use form 2210 to show that if I chose that.
(4) If within 5 years I came close to needing beyond the converted amount I have another Roth that I started the first year they came out so I would use that.
If you're past 59.5, there's no penalty for withdrawing from a Roth in less than five years. Provided the Roth account you withdraw from has been in existence for at least 5 years.
This link also confirms what we have discussed so far. But it doesn't cover one area.
From the form my broker sent me to do the conversion: Use this form to convert to a new Roth IRA or to an existing Roth IRA A. Open a new Roth IRA and convert my existing Traditional IRA (Contributory, Rollover, SEP-IRA or eligible SIMPLE IRA). B. Convert my Traditional IRA (Contributory, Rollover, SEP-IRA or eligible SIMPLE IRA) to my existing Roth IRA.
I plan to open a new Roth (Option A) for this conversion. I wonder what portion of the account would be subject to the 5 year stuff if I was under 59-1/2
I know where you are coming from but I don't march to that drummer.
I have been heavy into the market since the early 1980's.
I have never paid an estimated tax.
My thinking goes like this:
For starters, every penny I have is in the market.
About 10% in stocks, the rest in the ETF QQQ.
So, come April 15 of any given year I owe estimated taxes for the sells I have done so far this year.
If I elected to pay those taxes I would have to sell shares of QQQ.
Instead I elect to keep the shares and let them appreciate.
Same for estimated taxes in June, Sept, Jan.
Come the following April 15 when I have to pay the actual tax, the value of QQQ has appreciated so much that it totally overwhelms any penalty. So I sell some QQQ to pay the tax and ignore the estimated tax on this sell.
I will be converting a large Traditional IRA to a Roth IRA this year.
The reasons why I am converting the whole amount are complex and I don't want to get into them here (yet).
When I do this, I will owe income taxes of about 1/3 of the amount of the account.
I intend to not pay any estimated tax on the conversion. I know this results in a "penalty". It is not really a penalty, just the interest on the money I should have paid. I estimate that to be about 1.8% of the tax.
The reasons for not paying an estimated tax are complex and I don't wish to get into them here (yet).
I mentioned this to a tax preparer and he said I should pay the estimated tax at the time of the conversion.
Here is his reasoning:
"Example 1 if you don't have money withheld from the conversion. Roth rules are that you need to keep the conversion in the account for 5 years. If you withdraw in the 5 years you would pay tax on any gains.
On April 15, 2025 you owe 1/3 of the account in taxes now so you use the funds that were converted to pay the taxes. It is now labeled an early distribution, but you still will not pay an early withdrawal penalty because your basis is 3 times what you withdraw. After you pay your taxes your basis is 67% of what was converted.
Example 2. You have money withheld.
1. it does not count as a withdrawal.
2. Basis will stay the same.
I just figured you are going to pay the taxes no matter what, and this gives you a better tax basis"
I don't get his reasoning.
Does anyone know what he is saying?
I didn't read your entire post, but I can tell you about estimated tax payment. Your ES tax liability (in order to avoid tax penalty) is 110% of your most recent tax - ie, for the year 2024, your ES tax liability is 110% of what you owed in taxes in 2023 (or 100% of your 2023 tax liability if your income was below a certain cutoff). You must either divide that liability in 4 equal quarterly ES tax payments (if I remember correctly, the deadlines are something like April 15, June 15, Sept 15 and either Dec 15 or next Jan 15), or pay the entire ES tax liability by April 15 (which has just passed). Even if you do the conversion in December, you have to have enough ES tax paid in three earlier installments to avoid tax penalty.
If your tax liability on Roth conversion is greater than 110% of your total tax for the previous year, you can pay the balance of tax when you file the tax return. Example:
- your total tax liability in 2023 was $100k
- you convert $1.2M from trad IRA to Roth in Dec 2024, and expect a total tax of $400k on that conversion
- your ES tax liability on the conversion, which you have to pay in 2024, is not $400k but $110k (ie, 110% of last year's tax)
- you can pay the $110k tax liability either as a $110k payment before April 15, 2024, or in four equal installments of $27.5k paid by 4 different deadlines in 2024. The first deadline to pay the first installment of $27.5k was April 15, 2024.
- since you paid $110k as the 2024 ES tax, you can pay the rest of your 2024 tax liability (ie, the remaining $290k) when you file your 2024 taxes, by April 15, 2025. If you pay it that way, you avoid any tax penalty.
The first important point is that ES tax is not due when you make Roth conversion (or receive any other lump of taxable money), but either by April 15 of the tax year, or in 4 equal installments, the first of which must be made by April 15 of the tax year. The second important point is that you owe only 110% of your last year's tax in estimated payments. If your total tax for this year ends up being more than 110% of your last year's tax, you can pay the balance of your tax liability when you file the tax return for this year.
I didn't read your entire post, but I can tell you about estimated tax payment. Your ES tax liability (in order to avoid tax penalty) is 110% of your most recent tax - ie, for the year 2024, your ES tax liability is 110% of what you owed in taxes in 2023 (or 100% of your 2023 tax liability if your income was below a certain cutoff). You must either divide that liability in 4 equal quarterly ES tax payments (if I remember correctly, the deadlines are something like April 15, June 15, Sept 15 and either Dec 15 or next Jan 15), or pay the entire ES tax liability by April 15 (which has just passed). Even if you do the conversion in December, you have to have enough ES tax paid in three earlier installments to avoid tax penalty.
If your tax liability on Roth conversion is greater than 110% of your total tax for the previous year, you can pay the balance of tax when you file the tax return. Example:
- your total tax liability in 2023 was $100k
- you convert $1.2M from trad IRA to Roth in Dec 2024, and expect a total tax of $400k on that conversion
- your ES tax liability on the conversion, which you have to pay in 2024, is not $400k but $110k (ie, 110% of last year's tax)
- you can pay the $110k tax liability either as a $110k payment before April 15, 2024, or in four equal installments of $27.5k paid by 4 different deadlines in 2024. The first deadline to pay the first installment of $27.5k was April 15, 2024.
- since you paid $110k as the 2024 ES tax, you can pay the rest of your 2024 tax liability (ie, the remaining $290k) when you file your 2024 taxes, by April 15, 2025. If you pay it that way, you avoid any tax penalty.
The first important point is that ES tax is not due when you make Roth conversion (or receive any other lump of taxable money), but either by April 15 of the tax year, or in 4 equal installments, the first of which must be made by April 15 of the tax year. The second important point is that you owe only 110% of your last year's tax in estimated payments. If your total tax for this year ends up being more than 110% of your last year's tax, you can pay the balance of your tax liability when you file the tax return for this year.
I think you have it right. I didn't read into the details but as I said before, I never pay an estimated tax. I keep the money in the stock market and the gains far overwhelm any "penalty".
I think you have it right. I didn't read into the details but as I said before, I never pay an estimated tax. I keep the money in the stock market and the gains far overwhelm any "penalty".
I am not an investor, but I used to be self-employed, and I used to pay ES taxes, generally all at once in early April, in the amount of 110% of my last year's tax; I continue doing the same in retirement (my taxes are now very low compared with what I paid when I worked). I don't know whether investing the tax money and paying penalty for non-payment of ES tax is better or not.
But my point was that your ES tax liability is just 110% of your last year's tax. Any tax above that you can pay with your next tax return (there is no penalty of any kind for that).
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