Are Taxes Withheld From A Roth Conversion Considered A Penalty Distrib

[Guest irr7342]

If I convert my rollover IRA to a Roth IRA and instruct the trustee to have 20% withheld for federal taxes, are the taxes considered a penalty distribution? Can I also, within 60 days, redeposit the amount withheld for taxes? Thanks

Jason Cooke

[Michael Devault]

If an amount equal to that withheld for taxes is not put into the Roth IRA, it will be considered a distribution, subject to penalty.

For example, if the traditional IRA is $1,000 and you withhold $200 for taxes, coverting the remaining $800, at the end of the year, you'll pay taxes on the full $1,000 distributed from the IRA, plus a 10% penalty on the $200 not converted.

Continuing the example, you could pull $200 out of your pocket & put it into the Roth IRA so that $1,000 would be in it. Then, at tax-time, you'll owe taxes on the $1,000, and you'll have $200 credit from withholding to apply towards the tax.

If you intend to put the full $1,000 in the Roth, I would suggest that you consider not having money withheld for taxes. That way, you'll have use of the $200 in the above example until tax time. Uncle Sam doesn't pay interest on amounts withheld!

Hope this is of some benefit to you.

[John G]

If you can not pay the taxes on a Roth conversion out of non-retirement assets, then you should probably not do the conversion. Using the IRA to pay taxes reduces the size of your conversion and triggers penalties. This substantially reduces and probably eliminates the benefit of a Roth.

The 60 day rollover rule was originally intended for people requesting a check to give them enough time to redeposit the funds (originally an IRA to IRA issue of switching custodians). This 60 limit has tripped up a lot of folks who get the dates wrong, get distracted, spend the money, or forget to complete the transaction and that means taxes and penalties. Do not needlessly expose yourself to the risks of the 60 day rule.

When you ask for a check, tax witholding is mandatory. If you are moving your IRA assets to another custodian at the same time you convert, I recommend that you use a direct custodian to custodian transaction. You fill out papers with the new custodian and they "fetch" the funds from the prior custodian. No witholding. No 60 day issue. This is a much cleaner way to get the job done.

When you do a significant conversion, your tax liability will often trigger a need to file estimated taxes. Since estimated taxes are quarterly, you often get a few months of "float" before you need to make an IRS deposit. Sometimes you can avoid the estimated taxes by arranging additional witholding from paychecks.... and since this can sometimes be done towards year end, you can buy some additional time.

You may also want to delay the date of your conversion if you expect some additional funds from a tax return or bonus. You may also want to consider a partial conversion over a few years to reduce the tax burden and avoid tax bracket creep.

[BPickerCPA]

Withholding is NOT manditory on IRA distributions, unless you are subject to backup withholding.

The withholding rules apply to qualified plans only.