Roth Conversion Taxes

Submitted by Michael Copley on Thu, 2015-12-10 00:17

Hi there. I’ve decided to convert my traditional IRA to a Roth IRA. I’m 51. I have a few questions on the tax implications that i’d appreciate your professional clarification on please.

1. Can I have my traditional IRA custodian withhold enough federal income tax to pay the tax that will be due on the converted amount or should I pay the tax due from a separate account? I understand if I withdrawal money from the IRA account to pay the taxes, i’d be subject to a 10% early withdrawal penalty. But was hoping the custodian could withhold the money and avoid this tax penalty. I’m concerned about estimated tax payment implications if I don’t have them withhold taxes…and we’re in the last quarter so they’d all be due by Jan 2016 (I will start my partial conversion this month).

2. What code should the custodian use to code the conversion as a conversion and not an early distribution (e.g., code 1 or 2 or 7) that would provoke a 10% early withdrawal penalty. And if the custodian incorrectly codes the 1099R, what supplemental tax form would I use to file with my tax return to make sure the IRS knows it was a conversion of money and not a distribution of money?

3. My plan is to slowly convert (10%) of my traditional IRA money over to a new ROTH account over the next decade in order to keep the tax bill at a level I can manage from my existing income and keep me within my current tax bracket. Even 10%, however, is greater than the $6500/yr contribution limit. Am I correct that conversion isn’t subject to the contribution limit? IAW, I can convert some or all of my IRA over as many years as I want without penalty, correct?

Since I have no earned income (retired on a pension), I can’t make anymore contributions to the ROTH, but I have a sizeable Traditional IRA I want to convert over before I start drawing Social Security.

Regards,

Mike C



Submitted by Alan - IRA critic on Thu, 2015-12-10 01:50

  1. In most cases, you should NOT have taxes withheld from the conversion. Unless you replace the withheld amount within 60 days, the converted amount will be less than the distribution and you will owe taxes and penalty on the amount withheld, the same as if you withdrew the money and used it to pay a quarterly estimate.
  2. You would report the converted amount on Form 8606 and there will be tax but no penalty. The withheld amount would probably be shown on a separate 1099R with code 1 for the early distribution. It is possible some custodians would include the total on a single 1099R with code 7 or code 1. If you happened to qualify for a penalty exception on the withheld amount, you would file a 5329 to claim that exception. Each exception type has it’s own coding you would show on the 5329. Otherwise, you would owe the 10% on the withheld amount. The 8606 will show that you converted the rest.
  3. Conversions are not subject to the contribution limit. You can convert as much as you are willing to be taxed on. You can also make as many partial conversions as you wish each year. The custodian will just add them up on your 1099R. If you change your mind you can also recharacterize (reverse) all or part of each individual conversion. You might do that if you could not afford the tax bill or if the conversion suffered large losses. Generally, it is wise to convert prior to claiming SS benefits and after you retire since your tax bracket at that time will be lower. But you should be able to pay the taxes from other funds and probably through quarterly estimates.

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