10% penalty on 403(b) conversion to Roth IRA

Submitted by Christopher Combs on Thu, 2017-11-16 13:58

Dear Alan,

I have a client who is 29 years old. She is interested in converting $14,000 from her 403(b) into a Roth IRA. My understanding is that, if she elects to have income taxes withheld on this amount during the conversion, she will be subject to a 10% penalty on the amount withheld because it is treated as an early distribution.

Am I correct?

I read an article that states this is the case with a conversion from a Traditional IRA. I wasn’t sure if the rules were different with a conversion from a 403(b).

Thanks in advance,

Chris



Submitted by Alan - IRA critic on Thu, 2017-11-16 17:33

Yes, the withholding amount will be taxed and penalized UNLESS she replaces that amount by using her other funds to roll the withheld amount to her Roth IRA within 60 days of the distribution. Some people who will be underwithheld due to a late year conversion do exactly this to bring their total withholding for the year up to a safe harbor amount to avoid underpayment penalty. Paying a quarterly estimate in January is not as effective unless she files the onerous 2210 annualized income installment form which is a complex and nasty form that people usually want to avoid. If her other withholding for the year is already enough to meet a safe harbor (eg 100% of last year’s tax liability), there is no need for withholding from the Roth rollover.

Submitted by Ben Meyer on Thu, 2017-11-16 20:03

If permitted by the 403(b) plan, the client can perform a direct rollover from the 403(b) to a Roth IRA.  This way the funds will be sent directly from the 403(b) plan to the Roth IRA.  This will avoid both the 10% premature withdrawal penalty and also the withholding.  The tax would need to be paid from separate funds.  Withholding from other income sources can possibly be increased before the end of the year to avoid filing form 2210.

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