Tax Question related to large Roth Conversion

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GeoMetry
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Joined: Mon Jan 31, 2011 8:26 pm

Tax Question related to large Roth Conversion

Post by GeoMetry » Wed Oct 09, 2019 6:03 am

If I decide to do a large Roth Conversion late in the year, will I be subject to a penalty for not paying enough taxes earlier in the year? My normal federal income tax bill is around $60K. It is all paid via payroll withholding. I generally hit that target pretty close. (within $2K) I might convert $200K to Roth this year which would push my federal income tax bill up to around $105K. If I did that conversion in November or December, what do I need to do to avoid the penalty for underpaying estimated taxes?

livesoft
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Re: Tax Question related to large Roth Conversion

Post by livesoft » Wed Oct 09, 2019 6:30 am

Don't underpay and just pay your 4th quarter estimated taxes on time.
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Katietsu
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Re: Tax Question related to large Roth Conversion

Post by Katietsu » Wed Oct 09, 2019 6:55 am

There have been a couple threads with well written responses in the last couple weeks on this topic.

The best choice in your situation is probably to meet the safe harbor requirements through withholding, if possible. Since it sounds like your income is over $150 k, you would need to have withholding that is at least 110% of your 2018 tax liability.

Alternatively, you can make a single estimated tax payment. You will then need to complete a form 2210 and report your income for each of the four quarters. How much work this involves depends on your personal situation.

I question your numbers though. With an income tax liability of 60 k, I have not been able to figure out a way to convert 200 k while only incurring 45 k more in taxes.

Topic Author
GeoMetry
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Joined: Mon Jan 31, 2011 8:26 pm

Re: Tax Question related to large Roth Conversion

Post by GeoMetry » Wed Oct 09, 2019 8:10 am

Katietsu wrote:
Wed Oct 09, 2019 6:55 am
I question your numbers though. With an income tax liability of 60 k, I have not been able to figure out a way to convert 200 k while only incurring 45 k more in taxes.
You are correct I misstated my current tax bill. My current tax bill is more like $40K, the increase would be $65K. (That's just Federal) It sounds crazy to me but I have run thousands of scenarios and in my situation it appears that the best course of action is to aggressively convert to Roth and pay the taxes ASAP. I could stretch it out but the very slight financial advantage is overshadowed by the increased complexity of dragging it out over the rest of my life. I can handle all these calculations and transactions now but based on what I see happening to older folks around me, I think this will be too complicated for my 80 year old self.

HeelaMonster
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Re: Tax Question related to large Roth Conversion

Post by HeelaMonster » Wed Oct 09, 2019 9:50 am

GeoMetry wrote:
Wed Oct 09, 2019 8:10 am
You are correct I misstated my current tax bill. My current tax bill is more like $40K, the increase would be $65K. (That's just Federal) It sounds crazy to me but I have run thousands of scenarios and in my situation it appears that the best course of action is to aggressively convert to Roth and pay the taxes ASAP. I could stretch it out but the very slight financial advantage is overshadowed by the increased complexity of dragging it out over the rest of my life. I can handle all these calculations and transactions now but based on what I see happening to older folks around me, I think this will be too complicated for my 80 year old self.
I can appreciate not wanting to drag it out over the rest of your life... but is there a reason to not wait until you are retired and do some strategic conversions at that point, when you should be in a lower tax bracket? Not questioning your logic or calculations, just trying to understand in relation to my own situation.

vtMaps
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Re: Tax Question related to large Roth Conversion

Post by vtMaps » Wed Oct 09, 2019 10:17 am

HeelaMonster wrote:
Wed Oct 09, 2019 9:50 am
but is there a reason to not wait until you are retired and do some strategic conversions at that point, when you should be in a lower tax bracket? Not questioning your logic or calculations, just trying to understand in relation to my own situation.
For the OP, pay taxes now, avoid IIRMA later. For those with somewhat lower tax brackets, pay tax now, avoid the SS tax hump later.

Also, good to pay tax now while MFJ, rather than later as widow(er).

--vtMaps
The optimist proclaims that we live in the best of all possible worlds; and the pessimist fears this is true. --James Branch Cabell

Topic Author
GeoMetry
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Joined: Mon Jan 31, 2011 8:26 pm

Re: Tax Question related to large Roth Conversion

Post by GeoMetry » Wed Oct 09, 2019 10:27 am

I am pretty close to retirement today. I am also being pinched between my current income and IRMAA, taxation of our social security benefits (delaying to 70), RMDs, and the expiration of the Trump tax cuts. I have a 5 year window and about $1M to convert. After 5 years everything gets less favorable. I used the Excel Solver to run thousands of scenarios and this is the one with the best result. Of course I had to make assumptions, the assumption I chose to go with looking forward is; 2% inflation, current law will be unchanged, tax cuts will expire, social security benefits will be reduced after 2035, for the most part everything continues as it has for the past 30 years with a slightly lower long term rate of return. Oddly I am sort of hoping for a dip in the market like we had last year so I can convert a bit more at a lower cost.

Good Listener
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Re: Tax Question related to large Roth Conversion

Post by Good Listener » Wed Oct 09, 2019 10:58 am

GeoMetry wrote:
Wed Oct 09, 2019 10:27 am
I am pretty close to retirement today. I am also being pinched between my current income and IRMAA, taxation of our social security benefits (delaying to 70), RMDs, and the expiration of the Trump tax cuts. I have a 5 year window and about $1M to convert. After 5 years everything gets less favorable. I used the Excel Solver to run thousands of scenarios and this is the one with the best result. Of course I had to make assumptions, the assumption I chose to go with looking forward is; 2% inflation, current law will be unchanged, tax cuts will expire, social security benefits will be reduced after 2035, for the most part everything continues as it has for the past 30 years with a slightly lower long term rate of return. Oddly I am sort of hoping for a dip in the market like we had last year so I can convert a bit more at a lower cost.
I am in exactly the same situation is you now, although I've already done three years of conversions. My only different assumption from you is that I believe tax rates will go up and possibly well before the Trump tax cuts expire if a new law is passed, making conversions even more rational at this point..

Good Listener
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Re: Tax Question related to large Roth Conversion

Post by Good Listener » Wed Oct 09, 2019 10:58 am

Deleted. Duplicate.
Last edited by Good Listener on Wed Oct 09, 2019 3:52 pm, edited 1 time in total.

Bortky
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Re: Tax Question related to large Roth Conversion

Post by Bortky » Wed Oct 09, 2019 1:20 pm

Katietsu wrote:
Wed Oct 09, 2019 6:55 am
There have been a couple threads with well written responses in the last couple weeks on this topic.

The best choice in your situation is probably to meet the safe harbor requirements through withholding, if possible. Since it sounds like your income is over $150 k, you would need to have withholding that is at least 110% of your 2018 tax liability.

Alternatively, you can make a single estimated tax payment. You will then need to complete a form 2210 and report your income for each of the four quarters. How much work this involves depends on your personal situation.

I question your numbers though. With an income tax liability of 60 k, I have not been able to figure out a way to convert 200 k while only incurring 45 k more in taxes.
I am a little confused and I have tried to find previous posts to explain, but apparently I am bad at searching. If I want to convert (is that the right term?) 100k from a trad. 401k to a Roth 401k, do I need to pay an Q4 estimated tax bill on that 100k? Or is it enough that I pay (it is withheld as part of my job) the same amount of taxes that I owed last year?

Thanks!

Katietsu
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Re: Tax Question related to large Roth Conversion

Post by Katietsu » Wed Oct 09, 2019 1:48 pm

Bortky wrote:
Wed Oct 09, 2019 1:20 pm
Katietsu wrote:
Wed Oct 09, 2019 6:55 am
There have been a couple threads with well written responses in the last couple weeks on this topic.

The best choice in your situation is probably to meet the safe harbor requirements through withholding, if possible. Since it sounds like your income is over $150 k, you would need to have withholding that is at least 110% of your 2018 tax liability.

Alternatively, you can make a single estimated tax payment. You will then need to complete a form 2210 and report your income for each of the four quarters. How much work this involves depends on your personal situation.

I question your numbers though. With an income tax liability of 60 k, I have not been able to figure out a way to convert 200 k while only incurring 45 k more in taxes.
I am a little confused and I have tried to find previous posts to explain, but apparently I am bad at searching. If I want to convert (is that the right term?) 100k from a trad. 401k to a Roth 401k, do I need to pay an Q4 estimated tax bill on that 100k? Or is it enough that I pay (it is withheld as part of my job) the same amount of taxes that I owed last year?

Thanks!
It is enough that you have withheld from your W-2 job at least the same amount of taxes as your 2018 tax liability. This is called a safe harbor. However, if your 2018 AGI was over $150,000, then the amount of withholding for the safe harbor to apply needs to be at least 110% of your 2018 tax liability.

Bortky
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Joined: Tue Jul 17, 2018 9:43 am

Re: Tax Question related to large Roth Conversion

Post by Bortky » Wed Oct 09, 2019 2:09 pm

Katietsu wrote:
Wed Oct 09, 2019 6:55 am

It is enough that you have withheld from your W-2 job at least the same amount of taxes as your 2018 tax liability. This is called a safe harbor. However, if your 2018 AGI was over $150,000, then the amount of withholding for the safe harbor to apply needs to be at least 110% of your 2018 tax liability.
Thanks! So just having money consistently withheld by my employer is not enough, I need to make sure it is 100% of my previous years tax obligation.

Katietsu
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Joined: Sun Sep 22, 2013 1:48 am

Re: Tax Question related to large Roth Conversion

Post by Katietsu » Wed Oct 09, 2019 3:10 pm

Bortky wrote:
Wed Oct 09, 2019 2:09 pm
Katietsu wrote:
Wed Oct 09, 2019 6:55 am

It is enough that you have withheld from your W-2 job at least the same amount of taxes as your 2018 tax liability. This is called a safe harbor. However, if your 2018 AGI was over $150,000, then the amount of withholding for the safe harbor to apply needs to be at least 110% of your 2018 tax liability.
Thanks! So just having money consistently withheld by my employer is not enough, I need to make sure it is 100% of my previous years tax obligation.
IF you want to do a big Roth conversion and avoid a penalty based on your 2018 return.

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FiveK
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Re: Tax Question related to large Roth Conversion

Post by FiveK » Thu Oct 10, 2019 12:49 am

Katietsu wrote:
Wed Oct 09, 2019 1:48 pm
It is enough that you have withheld from your W-2 job at least the same amount of taxes as your 2018 tax liability. This is called a safe harbor. However, if your 2018 AGI was over $150,000, then the amount of withholding for the safe harbor to apply needs to be at least 110% of your 2018 tax liability.
+1

See the following link for all the safe harbor options (in other words, if one is not someone "Who Must Pay Estimated Tax"), then one has reached a "harbor safe from penalties."

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