Roth Conversion Quarterly Estimate Question

Submitted by Jeffrey Truchon on Fri, 2020-02-14 16:43

I have a client that that is converting a significant portion of his traditional IRA to Roth over the next 10 years, prior to age 70, to be able to pass this money onto his kids in a tax efficient manner. The amount that we’re converting annually is going to force him to make quarterly estimates. My question is, if we decide to process these conversions quarterly, and we have the custodian withhold both Federal and State taxes from the converted amount, will that suffice the quarterly estimates for my client? Or are we better off taking a distribution from the IRA (the amount that would have been withheld for taxes), and have the client pay in manually? We’ve discussed the option of paying the tax liabilities out of their liquid cash, but they’ve decided to withhold the taxes from the converted amount. Thanks in advance for your help!



Submitted by Alan - IRA critic on Fri, 2020-02-14 19:48

Client will now have either one or two extra years before his RMDs begin, so he can convert less each year. Taxes paid by withholding from the conversion distribution are treated as being paid equally througout the year, so client could postpone the entire annual withholding  until late in the year, therefore holding on his money longer. Estimates are only credited when they are paid, and therefore would have to be paid quarterly, unless Form 2210 A1 is filed and that form can be challenging. Obviously, if withholding is taken from an IRA distribution, the amount left for conversion will be less, or the total distributions will have to be increased to equal both the amount to be converted plus the withholding.

Submitted by Jeffrey Truchon on Sat, 2020-02-15 12:56

Hi Alan, Thanks for the response. The client has great pensions and is looking to convert by 70 to get as much done prior to starting SS, rather than focusing on RMDs. My question, when you say he could postpone the entire annual withholding until later in the year, do you mean he should pay his estimates out of his savings, convert just what he’s looking to put into Roth, then replenish his savings with a distribution to cover the tax estimtes paid at years end? Thanks in advance for your help!

Submitted by Alan - IRA critic on Sat, 2020-02-15 14:39

No, he could avoid estimates altogether if he decides to use an IRA distribution to pay the conversion taxes. He could have combine withholding from his pension to cover his taxes exclusive of the conversion, then do the conversions as early in the year as he wishes, then determine the additional taxes due to the conversion and take a distribution from the IRA in December equal to the amount of taxes due for the conversion. Most custodians will allow up to 99% of a distribution to be withheld, although there are some states for which they may not withhold.  If he does not pay estimates now, perhaps he is already withholding from the pensions, but I am assuming he does not want to increase that amount because he needs the net pension payment for living expenses.  Of course, he could still do estimates if he wants to, but may still need to take IRA Distributions to fund the estimates, so in that case he would need to take money out of the IRA anyway. Withholding eliminates any time requirements typical of estimates and can be done with just one distribution late in the year. There are a number of options, but I think a one time distribution (late in the year to allow him to hold his money longer) is the best option.

Submitted by David Mertz on Sat, 2020-02-15 15:58

If the client has sufficient assets outside of the retirement account such that a distribution is not needed to cover the taxes and the client chooses to have taxes withheld with the Roth conversion rather than make estimated tax payments, the client will want to substitute other funds and indirectly roll over within 60 days the amount withheld for taxes to complete the conversion of the entire gross amount distributed.  In this case, making sufficient timely estimated tax payments to avoid a tax underpayment penalty might be easier.

Submitted by Jeffrey Truchon on Mon, 2020-02-17 14:47

Hi Alan, thanks again for taking the time to explain this. Unfortunately, I’m still a little confused. As you correctly assumed, the client is not looking to increase the tax withholding on his pensions as that money constitutes his monthly income. He is also not looking to pay the taxes out of his liquid cash account (which is ample), as he wants to keep that money completely liquid and at their disposal. Therefore, he is looking to pay the taxes out of the amount converted (IE – Convert $200k, withhold/distribute $50k for tax liabiltiy, net $150k in Roth). Could you please explain again (sorry) how he can avoid paying estimates by using an IRA distribution to cover the taxes? I’m sure I’m not far off from understanding this, and I appreciate your patience and assistance!

Submitted by David Mertz on Mon, 2020-02-17 16:34

To me it makes little sense to avoid using money from his liquid cash account to pay the taxes just to maintain a large balance there.  The money he would otherwise take from the traditional IRA can be converted to the Roth IRA instead and kept there in liquid investments.  Since he is over age 59½ he can tap that money in the Roth IRA whenever he wants, tax and penalty free.  Why have the money earning taxable interest in a non-retirement account when the same money can be earning interest tax free in the Roth IRA and for the most part can be just as accessible?  Depending on the circumstances, that money in the Roth IRA might also be better protected against creditors.

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