403(b) direct Roth conversion withholding
I directly converted the entirety ($10,000 to keep the numbers simple) of a 403(b) fixed annuity to a Roth IRA and the financial services company withheld 20% ($2,000) because I did not indicate on the form to not withhold. Thus, $8,000 ended up in the Roth IRA.
I wanted to maximize the amount in the Roth (the full $10,000) and not use tax advantaged funds to pay the taxes. If the financial services company does not refund the withheld $2,000 amount, I am looking for an alternative way to get the withheld amount back into tax advantaged status.
I know when an IRA distribution is received and taxes withheld it is possible (within 60 days) to put the entire amount back into an IRA by using outside funds to pay back the amount withheld. Something similar is what I would like to do in this case but am not sure if it is allowable.
Could I pay back the amount withheld right into the conversion Roth IRA without any recharacterization or redesignation?
Is it permissible to redesignate this type of conversion (403b directly to Roth)? I.e., leave the $8,000 in the same account and just have the title changed from Roth IRA to Traditional IRA. If so, could I put the withheld amount back into the redesignated IRA?
Is it permissible to recharacterize this type of conversion (403b directly to Roth)? If so, should the transfer of $8,000 be into a Traditional IRA or back into the original 403(b) account source of the funds? Presumably interest on the $8,000 since the conversion should be added but I am not sure. Using outside funds, could I put the withheld amount back into the account receiving the $8,000 (plus interest)?
If the above is all wrong, can you think of any other way to get the $2,000 withheld back into a tax advantaged account in a way which will pass muster with the IRS?
Thank you very much for any suggestions. They are much appreciated.
Permalink Submitted by Alan Spross on Thu, 2010-03-11 02:18
As long as you come up with $2,000 to complete the direct conversion within 60 days of when you think the IRS received the withholding, your conversion will be complete. There is no need to recharacterize anything unless you do not want to pay taxes on the 8,000 already converted or the 10,000. In that event, the recharacterization would have to go into a TIRA account as it cannot go back to the 403b and you would still have to come up with the other 2,000 to add to the Roth or the recharacterized TIRA.
Only downside is that the IRS will hold the 2,000 until you file your return for the distribution year. Perhaps you can reduce other tax payments for that year to effectively recover some of this amount sooner.
Permalink Submitted by Alan Sheldon on Wed, 2010-03-17 07:41
Your reply is a big help, Alan. Thank you. The financial services company is still working on refunding the withholding and putting it into a Roth IRA (which would complete the conversion). I have no assurance that the refund is certain though and don’t want to risk it falling through. With the 60 day deadline fast approaching, I think it makes sense to go ahead and complete the conversion of the amount withheld with outside funds (as you described) [I assume that it doesn’t matter if it goes into the exact same Roth account as the $8,000, just that it goes into any Roth IRA].
If the IRS withholding refund goes through first, I could put a stop payment on the outside funds check and if the outside funds check is deposited before the IRS refund happens I could try to stop that process. What I’m worried about is if somehow both the $2,000 IRS refund and the $2,000 outside funds check both go through—there would be $12,000 in the Roth IRA instead of the full $10,000 originally directly converted from 403(b). I wonder if the order of which hits first makes a difference. Even if immediately corrected, would the act of going over $10,000 get me in trouble with the IRS? If this were to happen, I’m not sure how to best get the excess $2,000 out of the Roth.
If I simply withdraw $2,000, would that be 1099-R coded like a “corrective distribution” of an “excess contribution” and not cause any problem with the IRS? Should interest on that $2,000 also be withdrawn?
The only other thing I can think of is to have the company send the refunded $2,000 (plus interest?) back to the IRS as withholding and then get it back after filing a 2010 return.
Permalink Submitted by Alan Spross on Thu, 2010-03-18 02:24
I am a little surprised that the plan would even agree to abort the withholding since it apparently was not their error. Must be that this is recent enough that the funds have not been sent to the IRS yet. However, if they cannot commit to action by the 60 day deadline, they are leaving you in limbo and you might be better off to tell them to forget it and substitute your own funds in the Roth. The actions of the plan, though well intended, appear to carry the potential of foul ups which could be a real headache to straighten out. They would probably be pursuing a process that they are not comfortable.
However, if 12,000 ended up in the IRA as a rollover contribution after all this, you would have to correct it as you would an excess regular Roth contribution to the Roth. You cannot recharacterize it because you are working with more than the plan actually distributed (12k vrs 10k). If you are eligible for a Regular Roth contribution of 2,000 you have not yet made, you could instead ask to have your 2,000 check reclassified as a regular Roth contribution instead of a conversion and avoid the excess contribution treatment.