Roll to Roth 2008-30

[JanetM]

I understand that the 10% penalty does not apply to direct rollover to Roth and that the statutory 20% withholding does not allply. The participant rolls 100% of balance to Roth and then pays the tax due out of pocket the following year.

I have terminated participant who wants to roll 80% of balance to Roth and wants us to withhold the 20%. Told her we could not do that. She could roll the 80% to Roth and take lump sum of the 20% - with 20% of that withheld and then she could send the amount received as estimated tax payment.

Anyone have better way to do this? Participant can't afford to pay tax on rollover if 100% goes into the Roth. She understands if she rolls 100% to Roth and takes $ from Roth to pay taxes next year the amount withdrawn will be subject to 72t penalty.

[Appleby]

Hi Janet,

2008-30 Q&A 6 says in part "a distributee and a plan administrator or payor are permitted to enter into a voluntary withholding agreement with respect to an eligible rollover distribution that is directly rolled over from an eligible retirement plan to a Roth IRA."

I am not sure if you are saying you do not want to, or think you cannot...

Denise

[masteff]

I've always understood the 20% mandatory w/h'ing to be a minimum and not a maximum. So unless your trustee's system is badly hardcoded, you should also be able to accomplish it by allowing a w/h'ing election of 100% on the 20% non-rollover portion. (I can see how they'd not be programmed to allow w/h'ing on a direct rollover, as that wouldn't have happened in the past.)

[JanetM]

Let me restate this. The $ rolled to the Roth are not subject to 72t. Since the withholding isn't rolled to the Roth I am being told it does not fall under the exemption from 72t. To escape the penalty, 100% must roll to Roth and the tax must be paid out of pocket.

We can withhold on Roth rollover, but the tax & penalty part is what is confusing. I want to be able to explain this to people who want to roll to Roth.

[GMK]

One way to explain it may be to point out that the conversion follows the same rules as converting a traditional IRA to a Roth, including that any amount not rolled over to the Roth is subject to withholding (10% unless you elect some other percentage, including 0%) and if you are under age 59-1/2 is subject to 10% penalty tax.

Unfortunately but inevitably, young people (=under age 59-1/2) take the big 10% hit rolling over to a Roth.

[masteff]

In order for w/h'ing to completely cover the amount of extra tax and penalty due, use the following fomula (where T = expected fed&state tax bracket % and P = 10% penalty):

% to withhold = { T + [ (T*P) / (1-P) ] }

Example, given T=27% and P=10%, it would be: { .27 + [ (.27*.1) / ( 1-.1) ] } = .30