How to Avoid Tax Underpayment Penalties When Performing a Roth Conversion!
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- Опубліковано 18 жов 2024
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Do you know you can't just wait until tax time in order to pay a balance you owe to the IRS?
If you do, you may be subject to a tax underpayment penalty and have to pay future quarterly estimated taxes. Neither of which are very fun...
Withholding the right amount for taxes is a problem throughout retirement but specifically is a problem that can arise with Roth Conversions.
Roth Conversion taxes can be paid in numerous ways. From withholding taxes right out of the conversion to paying taxes from your checking or savings accounts.
Regardless of how you pay taxes, the IRS will force you to pay those taxes at a specific time or face IRS penalties.
In this video, we are going to clear up a hot button issue in regard to Roth Conversions - How to pay the right amount in taxes at the right time
We will discuss:
✅ How to pay estimated taxes in order to avoid underpayment penalties
✅ The way you withhold taxes will vary based on what source you are paying those taxes from
✅ How to meet one of the three guidelines the IRS specifies you need to meet in order to avoid IRS penalties
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Correction ... "The IRS understands the time value of money ONLY when they are on the losing side"! Consider that for most workers, the model is to overpay via payroll deductions and then get money back. Apparently, the IRS likes "interest free loans" ONLY when they are the recipient!!!
Keep in mind that the government is you and me. "We the people" don't want to loan money to people who are bending the rules - I don't want to be taken advantage of, and neither do you. As for people who intentionally overpay (it's true, I know many people do this) that's their choice. It comes down to lack of discipline in saving money; having it withheld from their paycheck so they never have it in their hands to spend works for them.
@@jacksons1010 Sadly, regulatory agencies under the Executive Branch are not elected by 'you and me'. While one might think that they operate for POTUS, in practice that is simply not true. The founding fathers would roll over in their graves if they saw how these agencies diminish freedom and liberty of ordinary citizens. Case in point, the IRS under Lois Lerner sat on or denied applications for 501(C)(3) organizations that were of a conservative political orientation, while at same time rubber stamping any/all similar applications for liberal environmental organizations, as comparison. Regulatory agencies at the Federal level are most often comprised of life-long career bureaucrats and are staunch Democrats because their livelihoods depend on sustaining big bloated federal government.
@@chumbawumba1959 That accusation against Lerner is pure FoxNews nonsense. Several overtly politically-oriented conservative organizations applied for 501(c)(3) status as non-profits. That's not what 501(c)(3) is for, and those applications were correctly denied. There is a separate section of the law for political parties, PAC's etc. But sure...she was "rubber-stamping" applications for environmental organizations properly applying under 501(c)(3). The problem here is perception, thinking that environmental = liberal and turning into partisan politics. That in turn makes you suspicious of all government not doing what YOU think they should do. Could be you are mistaken sometimes, misled by politically-motivated and biased news organizations. We elect the people who run the agencies - that's how a republic works. We do not have a direct vote for every position from dog catcher to IRS administrator - that would be chaos.
@@chumbawumba1959 Yup.
Screw the government officials.
Breaking the law themselves. While pointing their finger at us. Like we're the bad guy.
Was there ever a more true statement? 😂🙄
Thank you for this video.
I wish more people would teach more in HOW to pay the taxes
A good reason not to pay the taxes out of the conversion itself is that you lose some of the tax deferred investment which you can't get back unless you go back to work and earn more money. I paid the taxes on my Roth conversions directly from savings online to both the state and federal governments and had no issues.
Dear murray1575, I'd like to do the same. So, ¿could I do a Roth conversion (modest), and send the (say 20% fed, 5% state) online (from savings) at the same time, and have no issues? ¿Will I have to pay quarterly estimates for the year, as Eric in his video said?(9:24-9:32). Any comments welcomed. Thank you. (I don't mind paying more ahead, to avoid any issues with IRS, and getting a refund, if it turns out thus).
@@tonyd1149 If you pay something close to the right amount, then you'll be fine with the IRS and your state. I have done this twice already.
I would recommend people make their 1040ES payments online. Use the IRS form as a worksheet if you must, but don't file a paper form and don't send checks in the mail. When you do it online you get immediate confirmation of the transaction (take a screenshot of that if you're nervous) and an e-mail confirmation usually arrives the next business day. I suppose it depends on how comfortable you are with using a computer, having proper backups etc. You can always print your IRS statements and file that to document the payment - do the transactions online but keep paper records if you feel the need to.
You're right. We have had too many items lost in the mail or first going to a wrong address.
I took pictures of checks and documented government deposits of checks.
Eric, you and Tony are crushing it! It's like you guys are reading my mind as to what I'm looking for as I execute my first Roth conversion and rebalance my investment portfolio. Keep these great videos coming.
Thank you Victor! We'll keep them coming if you keep watching :) Deal?
Don't forget to prepare the Form 8606 which shows the IRS the conversion from SEP to ROTH.
Thanks for clearly educating us retirees.
I have previously taken multiple IRA distributions or Roth conversions during year (usually two) and have no federal withholding taken early on; the last distribution/conversion of the year (December) gets the lion's share earmarked for federal withholding. Last I heard there is no tax penalty for this strategy and I get the benefit of the time-value of my money. I do estimated quarterly payments for state and local school income tax.
This year I will plan estimated quarterly federal tax payments too so I can use post-tax brokerage account to pay taxes on a Roth conversion.
When my two sons (not retired) sell stock from company ESPP for big capital gains, I mentor them through increasing their paycheck tax withholding for the last couple months of the year.
I did a Roth conversion from an IRA in December. I plan on paying the tax from my savings. My CPA told me the tax on the conversion will be due on April 15th. He never mentioned a penalty for not paying at the time of the conversion.
That is exactly what I was planning on doing this year converting in December 2023 and then doing my taxes in February and paying the taxes then
So since you wrote this year ago did that work out OK for you when you do it that way
I had an adviser tell me the same thing the tax is not due at the time of conversion nor quarterly payments. I don't know what the truth is so I converted this year in Jan and transferred the tax estimates to FED and State in Jan. I use money separate from the conversion. This ties that money up at the IRS for more than a year and it could have been invested and paid next year. I hunt all over the web and cannot get a clear answer on this. Next year I'm going to do 4 conversion quarterly and send four tax estimates each quarter. This is insane and it should be clear rather vaguely argue well the IRS cares about the time value of money. When you do a conversion there's no IRS form generated to dictate when tax estimates are do either.
he did not go over the schedule of the 1040 ES form - stop the video at #11:05 and see the asterisks attached to the Q4 - Jan payment vs Tax Filing date payment ---- if paid in full by end of Jan there is not need to do estimated tax & therefore no penalty. Of course the form does not address penalties if late but it seems conversion/taxes are coupled by quarter. I would check the actual late fee publlication or talk w/ your accountant for the timing & penalty eval for quarterly timings --- it is i bellieve a simple % of total tax missed * time value of money, useful since i do usuallly 2 ROTH conversions, one at the beginning and one for Q2. i did do one extra in Q4 & paid the tax by the mid-Jan duedate for Q4 estimated tax.
If you are an employer and pay yourself with a timely payroll check, and/ or do your own payroll, when you get close to the end of the year say in December, while writing your last few payroll checks to yourself, and calculating the appropriate withholding taxes before you write your check, just calculate a little more withholding taxes, both federal and state, and remit those taxes as you normally do to the IRS. So yes, your withholding taxes will have ballooned, but at least you won't be penalized for not doing the 1040 estimated taxes in the interim. Been doing that for years, and it works.
Great video. How does the IRS know that my extra online 1040ES payment was for the conversion? I have a small biz so I already make quarterly estimated payments but I made an extra payment when did my conversion last week. Thanks
The penalty is usually negligible and not worth paying the taxes early. You get to keep the growth on not only the estimated tax you dont pay, but the money you pay on the penalty which usually isn't billed until July or August.
So if you plan on doing 2 or 3 conversions during the year... When you fill out the work sheet (let's say after a 1st QTR conversion), do you use the total amount you will convert during the year? And thus - make quarterly payments based on your "planned" conversions? Or - is it more of a "pay as you go" strategy? My tax plan shows I can convert $41,000 next year at 12%. So my tax payment would be $4,920 - is it that simple? (I know - there is some state tax as well). If I convert an extra $10,000, it would be taxed at 22% ($2,200). >>>>>>> Let me add this: I found a tax calculator on AARP. Plugged in all the projected amounts ---- it computes the tax (and handles long term gains) . I can calculate how much I may be short on federal tax.
thanks for the info on the calculator.
i just calculate the tax on the converted amount, as you said, noting the tax bracket (total i expect it to be in after all income streams included - I have RMDs as well) and use tthe online payment system to withdraw the amount from my bank account.
@@kevinkanter2537 It seems to work for me. I hate surprises when it is time to file! LOL.
Thank you. Should you add that if you are under age 59.5 and convert to Roth, if you pay the tax with IRA funds, you will be penalized 10%?
Thank you for that added tidbit. It seems obvious in retrospect, but is a component I hadn't considered yet.
Can’t I do a 62,400 conversion at the beginning of the year, with no tax payments, then a 17,600 conversion at the end of the year, marking it as 100% withholding? IRS treats withholding as distributed through the entire year, so unlike a Q4 ES for the year, which has timing issues, it’s considered to have covered the added AGI?
Funny how they understand the time value of money but don't give you interest if you get a refund because you overpaid during the year. it's the tails you win and heads you win for the IRS.
Thank you very much for your Videos! Your wife should be very very happy to have a Husband who is a Financial Planning Advisor with Tax Expertise and Retirement Planning, including Healthcare Planning. Now, Jumping in the Bed in the Higher Bed Frame with so much extra storage under to Save Space is much more pleasant than having a professionally made bedframe made in IKEA which would break from a 4 year old jumping on it one night telling us he was a Batman or Superman or Spiderman or Aniken from Star Wars (most of our starter furniture from IKEA for $12,000 in a small 2 bedroom city apartment was broken by the time my son became 9 years old growing up with this furniture from age 4). Please tell your Mom and Dad you are the Best Son and Husband who does so much more than Nerdy Financial Planning! ❤❤❤❤❤
Does it matter to the IRS if you take a Roth conversion at the beginning or end of year?
Thank you for the informative video. I will be 59 1/2 this July and looking to start partial Roth conversions each year from my traditional IRA which has a large net worth. Is it an acceptable strategy to take a larger monthly distribution from my traditional IRA to help pay for the Roth conversion taxes each year as opposed to withholding from the conversion amount as long as I am aware of what tax bracket I will be approaching when taking the conversion and distribution amounts into account? I know that I will be paying taxes on the IRA distributions but I won't pay a 10% penalty and the entire conversion amount will be available for my Roth IRA. More importantly, I will be spending down my traditional IRA which is my main goal before I have to start taking RMDs. Thanks again for the wonderful video!
I have read many times that the taxes on a Roth conversion are due April 15th of the following year. Nevertheless, I plan to do a conversion and a withdrawal at the same time and just have enough taxes taken out of the withdrawal to cover both.
You must *file* and reconcile all taxes by April 15, yes - but the IRS expects that income earned throughout the year is continuously taxed and remitted. Usually that occurs through payroll. A Roth conversion represents a potentially significant amount of money that could temporarily "escape" taxation for months, attracting the IRS's ire. That's why we are compelled to make an estimated mid-year payment in order to mitigate that situation and true-up our taxes owed along the way.
Thank you! Such valuable information.
Thank you for the video!
I am accustomed to making quarterly tax deposits here, so for the small conversions I have done thus far (a few backdoor Roth contributions, basically) I have just added to my self-employment quarterly deposits.
Glad it was helpful!
Thank you for your videos. My question is that my IRA custodian does not allow for tax withholding on a Roth conversion, so I usually send payment from a brokerage cash account as separate federal and state tax payments. However, for IRA withdrawals from this custodian I can specify the Federal and State (GA) tax to withhold. Can I over-withhold taxes on an IRA withdrawal to pay the taxes for a Roth conversion, as long as I make this transaction within the same quarter as the Roth conversion? Is this a reasonable strategy?
One can arbitrage ROI against IRS interest charge. E.g. Gain 15%, pay 6% penalty. Is risky, but no different than using margin.
Read thru the ways to avoid the penalties. As long as last year you over paid your taxes (got a refund) or this year you've paid at least 90%, then you aren't going to get a penalty. He's right you can pay as soon as you make the conversion, or quarterly (ideally for the IRS) but by their own rules, if you over pay what you owe in December every year, you can get it back as a refund in February and only be out your money for 2 months. Every year you'll have a refund so you'll be exempt the next year from a penalty. This should work even if you only send the IRS money in Decembers.
Can I just pay my Roth conversion taxes from my monthly pension withholding? I can easily increase or decrease withholding as needed.
I know how to pay online, but I can't find a way to fill out Form 1040 ES online. 1040 ES also says "Amount of estimated tax you are paying by check or money order." There's no option for "amount of estimated tax you are paying online." Do I send in form 1040 ES if I'm paying online?
There's no interest in helping people do these things without "experienced help". Lawyers write laws to guarantee you'll need to pay a lawyer and "experienced helpers" write the tax code to guarantee you'll need to pay "experienced help".
The key thing is to NOT pay taxes from the converted amount. This way, the full conversion value goes to work tax-free.
Can you comment on the safe harbor rule to avoid underpayment penalty? You must cover 100% of your prior year tax liability in the current year - 150% if your adjusted gross income exceeds $150,000 - in order to avoid the underpayment penalty,
The market is in correction and I am converting a large amount in the first half of 2022. I do not want to pay additional conversion tax withholding if I can meet the safe harbor amount.
Update: I spoke to the IRS over the phone and confirm the safe harbor rule is effective to avoid underpayment penalty. The rule is designed to deal with unusual tax year when the income is quite low or significant high, so the IRS will waive the underpayment penalty. I read the instructions for form 2210, which provides the conditions of the safe harbor rule: In general, you may owe the penalty for 2021 if the total of your withholding and timely estimated tax payments didn't equal at least the smaller of:
1. 90% of your 2021 tax, or
2. 100% of your 2020 tax. Your 2020 tax return must cover a 12-month period.
Higher income taxpayers. If your adjusted gross income (AGI) for 2020 was more than $150,000 ($75,000 if your 2020 filing status was married filing separately), substitute 110% for 100% in (2) above.
The 2022 instructions for form 2210 is not available yet, but shall be the same as the safe harbor rule is concerned. This rule will help me through the tough year for a major Roth conversion, because I will get enough time to apply for the home equity loan to pay the conversion tax. More importantly, I will know how much conversion has been completed later in the year, which is market performance dependent, so I know the loan amount I need to apply for the conversion tax payment. I hope this information is helpful for those who have similar situation.
@@charleschen4766 I'm totally in the same situation of yours, thank you so much for this info!!
What if you make a Roth Conversion early in the year and immediately make a partial estimated payment that is sufficient to meet the Safe Harbor Rule (100 or 110% of last year's taxes, depending on your income) and then wait to pay the remainder of the tax due on the conversion at the time of filing the return?
That looks like the easiest way to not have a penalty!
In another of your videos, I took from the information that (after a ROTH conversion) it was safe to do estimated quarterlies throughout the conversion year to avoid penalties. You didn't mention that in this video. Do I need to change my payment strategy?
How about using your RMD fron the IRA account to pay withholding. It would take IRA funds you cannot convert to a ROTH to pay the tax on the ROTH conversion.
If make conversion in 4th qtr then income mot even during year do u need to send in 2210 to prove it? Tax software says not to file 2210 but got a bill from IRS because filed electronic & not 210 submitted.
You can also reduce tax liability by making an IRA contribution. Nothing says you can't do both a contribution and a conversion in the same year.
If you already filed for 2023 and do a roth conversion this year, can you pay the tax on your 2024 return?
2021 Roth conversions apparently add to your 2021 MAGI. Your Part B Medicare premium in 2023 will be based on your MAGI in 2021. The threshold for a 2022 Part B increase is an MAGI < $182K in 2020. Can I assume I should keep my 2021 MAGI < $182K (or more ??) to stay below the 2023 Part B premium increase threshold?
Ray, good question. But sorry to say the guy who put this video together isn't the sharpest tool in the shed. If he cared enough, he'd read the responses, your inquiry for an answer, and just give you his expertise. UInfortunately, that won't happen. I won't come back. He's just n it for the UA-cam money. The sap. To answer your quesion, I would say, use the 182,000 K threshold as it's the best concrete limit there is available currently. It may go up, but it might not. Don't think it will go down, and it just might stay the same, so err on the side of caution.
I took a $50K IRA Distribution from IRA to pay off bills before I Retired? I had them withhold 20% Fed, 4.25% Mi so of $50K I only got about $37450? Can u have Taxez withheld from IRA conversion?
We converted $25K last December from a traditional to a Roth and got hit with an underpayment penalty as well as direction to pay $3800 quarterly this year.
We converted another $25K this Feb and sent IRS a check for 24% of that amount which exceeded the $3800 by almost $2000 for the first quarter. Can I deduct that from the $3800 due this second quarter?
Second question: we live in VA. How do we calculate the state tax on that amount?
Thanks in advance!
If I wait until November or December to do a conversion ans I know I have a hefty refund coming, will any of this matter? I'm in my 40s and would like to do Roth conversions in small chunks of $2000-5000.
So, what if you are moving your stock position from a IRA Rollover to a Roth which includes unknown capital gains from reinvested dividends, how do I determine those tax liabilities?
What about only converting the amount that the standard deduction is to to have no tax? If the only income i have is the conversion amount?
Then you would not need to withhold because your 'withholdings' would equal at least 90% of the taxes owed. You owe $0, you paid in $0 - IRS is happy.
If I do a Roth conversion equal to my standard deduction ($12,950) and my only other taxable income is (approximately) $13,000 in qualified dividends, could I be subject to a penalty on the Roth conversion? I think the answer is "no" but I want to be sure I'm not overlooking something.
Since I look for a down turn when I do my conversion (to get more into it) I find a period that I think is higher prior to that and take a 401K withdrawal (since you want to sell at a high point) in the amount of the tax and have the full withdrawal sent to the IRS and the state revenue dept. They don't seem to mind that method. I try to time it right and realize that if I miss it on one or the other that it's okay and probably better than if I took the taxes out when I did the conversion at the low point. Does this make sense?
Thank you very much
You are welcome!
What form do I receive from the Federal Govt to prove that I made the tax payment via the 1040-ES form? Do I receive a document to provide my accountant when my taxes are done - showing what I manually paid in taxes?
I could be wrong, but I do not believe the government provides any form or proof of payment for estimated taxes paid. As a result, I keep a scanned copy of my form 1040ES and bank check each quarter before mailing them. Additionally, once the check clears the bank I go online and print a copy of the cashed check as well. I do this for both federal and state taxes, but honestly have also never run into an issue in more than 5 years of paying estimated taxes.
@@chuck5386 Thank you, Chuck. Will do that.
i'm a DIYer and don't like paying for help - so how much is a simple conversion cost in terms of advice?
Could one also pay via IRS’s DirectPay online option?
I get completing the 1040ES for Federal but what about state?
I like your videos. You do a better-then-average job of covering the topics I've watched, most recently on various aspects of Roth conversions. Your annotated graphics are a great balance of art and content. Simple is good.
I have a suggestion or two, though, and they may sound weird or petty. Please know that I offer them as a friend who wants to help you improve your channel. (1) Your frequent pauses to lick your lips or swallow are distracting and detract from the presentation. If you took the time to edit them out of the posted video, I doubt anyone would notice the jump but it would eliminate the distraction and help your viewers stay focused on topic. (2) You might also consider speaking just a bit slower. Best of luck, and keep up the good work.
Noted. Thanks for the comment Ralph!
@@SafeguardWealthManagement I have watched dozens of your very helpful videos and have never noticed or been distracted by that! You do speak fast, but we can slow down the playback speed or play the video a second time. I do often pause it on your illustrations to study them. Just keep doing what you’re doing, and thanks so much for these awesome online resources!
I want to keep it simple, don't give them an excuse? Just take taxes out of conversion? Late last yr or before April of current yr before u file better?
Skip to 3:20 and put on 2X speed to get thru twice as fast
Great video. How does the standard deduction factor into this? I keep hearing to equal ROTH ladder conversions to the deduction and then you avoid all taxes. But I assume you’d be underpaying on the rest of your income still.
They should stop charging not working people penalties for not withdrawing from their retirement accounts but just conversation from one type to another. Not working people should not be forced to pay $200 each time they need to submit quarterly prepayments on top of regular Tax Return fee of $400. Custodians should be required to help people to send these Prepayments from within their customers Taxable account without extra Voucher and unnecessary paperwork for their Non Working people who converting from one type of retirement account to the other type or working people doing the same thing.
You have to consider who writes the tax laws, we have the foxes in charge of the hen houses. Their education and background is going to make sure they focus on giving people in their profession an income.
It may be easiest, but wouldn't withholding from the conversion under 59 and half, cause you to pay 10% early withdraw penalty?!?!
Yes he should've said this is okay for those 59.5 and older and provided caveat for those under 59.5 that there's 10% early withdrawal penalty.
GREAT!
Thanks for the video.
If I do a conversion in November are the taxes due before I file my taxes next April ?
Yes, the IRS lays out end of quarter deadlines. To be safe, I recommend paying taxes at the time of conversion
My wife converted $19,000 from an IRA to Roth IRA this past July at age 53. We have been planning on paying the tax in April. Are we going to be subjected to an underpayment penalty?
You get a bit of gimme on underpayment the first time it happens, so long as the amount of tax you paid (e.g. withholding from pay) is at least as much as you paid in 2020 OR 90% of what you owe including the conversion.
@@jacksons1010 Thanks for this information Jon. That helps.
Uh isn't the max 2021 HSA contributions $7,200, not 9,200 mention towards end of video?
If husband and wife on the HDHP are over 55, then they can add another 1k each for a total HSA contribution of $9200
Thanks Ron, beat me to it!
Ahh didn't know that, Thanks Ron!
I need more money!
Alot of gotchas and complexity. Maybe we submit and just keep it all in 401k and take it as salary with withholdings and live with any extra tax to avoid all this complexity and possibly penalties and paying large financial advisor fees.
You would be better off seeing a certified financial planner (some banks provide the service for free) than paying a financial advisor who is not a CFP.
The IRS knows TVM when you owe at filing. They do not understand TVM if you are due a refund.
Oh yes, Online is Safe? No hacker threats? 🤔
Your entire roth conversion strategy fails to determine NPV or net present value but instead just scares people on differential tax rates. Only forecasted cash flow for a given asset mix makes sense. Paying taxes earlier permanently removes the income generation capacity of the assets sold. No one in corporate America with any Capital budgeting experience would do huge Roth conversions solely based on rates. ! Only cash flow in dollars discounted at reasonable treasury rates is appopriate for apples to apples comparison.
You should watch more of our videos on the topic
SLOW DOWN the delivery. Is this an informercial???
I appreciate the fast delivery, as I usually turn speed to 1.75X to not waste time drinking from firehose of youtube content
What are the chances that this is our last year to convert? There were rumors that the Dems would/will take away conversions.
Last year to convert altogether? Minuscule chance. Chance that they eliminate backdoor Roth IRAs? 50/50 but I haven't had a retiree do a Backdoor Roth yet. Rarely makes sense. Elimination of backdoor Roths would be a bigger for younger, higher earners.
@@SafeguardWealthManagement Not sure I understand the difference. What is a backdoor ira?
@@beingright Backdoor Roth IRA. A high income earner not eligible to open or contribute to a Roth opens a traditional IRA with after tax income. Later converts it to a Roth (pays taxes only on the gains) and voila. The high income earner has a nice coveted Roth IRA.
@@MikeNaples Some of us look like high income earners because we have been converting. I am wondering whether I should just chunk the rest in this year or break it up to stay under the highest rates.
Good info BUT boy u need to slow down when talking! U might get a heart attack!!!