Now that we have to empty an inherited Roth in 10 years is it still a Rule of Thumb to pay the taxes on a conversion with money in a savings or checking account that was already taxed?
Is withholding the taxes on the conversion now considered an acceptable option?
The assumption is that the money in the Roth IRA is invested for growth, with that growth being tax free, otherwise there is little point to leaving any money in the Roth IRA, inherited or otherwise. The longer the money stays in the Roth IRA, the more potential there is for tax-free growth, so taking money out of a Roth IRA (or not having it get to the Roth IRA in the first place by having it go to tax withholding instead) when there are after-tax sources available that incur taxes on growth doesn’t really make sense. If later you find that you need to replenish those after-tax sources, you can take money out of the Roth IRA later after it has had more time to grow tax free.
Permalink Submitted by Alan - IRA critic on Wed, 2021-04-14 14:49
Paying taxes by either withholding from a TIRA distribution (conversion or not) or by quarterly estimates which are funded by extra TIRA distributions is undesirable because it shrinks your IRA balance and incurs additional taxes at the ordinary rate. While you could distribute from the inherited Roth tax free (if held 5 years since owner first contributed) to pay all or part of the conversion taxes, you would not be gaining as many additional Roth assets as by paying with other sources since you are depleting your inherited Roth faster.
If you inherited the Roth after 12/31/2019, the IRS just shocked the experts by stating in new IRS Pub 590 B that a 10 year rule beneficiary must also take annual RMDs in years 1-9. That would free up funds for you to pay conversion taxes to put your money in your own Roth with no RMDs. But it is also possible that the IRS messed up and the new Pub is wrong. Clarification should be forthcoming.
Bottom line is that you do not have to pay conversion taxes (if it is wise to convert in the first place) from any one source. You could combine sources with the goal of limiting tax increases in the conversion year. That said, if you are 70, your conversion window closes somewhat once you hit your first RMD distribution year (either 2022 or 2023).