taxes on Roth conversion
A client converted $220K to his Roth from traditional IRAs held in fixed annuities as direct transfers this year. The surrender periods had all ended on the 3 annuities. He and spouse are in the lowest tax bracket since they are using non-qualified funds for living expenses and have no other retirement income. Since the conversion will greatly increase his ordinary income, is it necessary to pay estimated taxes on this conversion or can he wait until April 2021? He will use taxable funds to pay the taxes, and all IRA funds were pre-tax. Thank you.
Permalink Submitted by Alan - IRA critic on Wed, 2020-08-05 19:19
While underpayment interest rates are low, he will owe a penalty unless his estimates or withholding meets a safe harbor, which in this case would be his tax liability for 2019, which sounds like it was much lower than 2020 will be. So if the 2019 tax bill was 2000, his penalty would only be based on falling short of 2000, not falling short of what his 2020 taxes will be. So his penalty would be small, but he would still owe quite a bit more in taxes next April due to the conversions. Usually, to avoid spiking the marginal rate conversions are done in smaller amounts over multiple years.
Permalink Submitted by Diane Ouellette on Wed, 2020-08-05 22:36
Thanks for your helpful and quick reply Alan. His 2019 tax liability filing jointly was only $1103, but he will be over the $150K threshold in 2020. I believe then that he would need to pay 110% of his 2019 liability, or $1213 to avoid any penalty. He has another $800K to convert and just turned 65, so he’ll be converting another $100K+ per year until age 72. He did not convert earlier since he qualified for significant ACA tax credits by using his after-tax dollars for living expenses.
Permalink Submitted by Alan - IRA critic on Wed, 2020-08-05 22:54
THe 110% applies to his 2019 AGI, which was not over 150k. Therefore, he only needs to withhold 101031 this year, since 1103 less 104 = 999 and he can then qualifies under the less than 1000 due penalty exception. So this is more about how much he wants to pay now vs. next spring than about any underpayment penalty. Are you sure his plan isn’t over converting? Every conversion dollar reduces his RMD income in retirement, and at some point the tax rate on the conversions will exceed the rate in retirement as those RMDs come down.
Permalink Submitted by Diane Ouellette on Thu, 2020-08-06 18:31
Thanks for the clarification re taxes. The over conversion is a great question that I will delve in further. Right now he is only earning about 2%/yr on the $800K IRAs that are all in fixed index annuities. He has been averaging about 7% per year in his 60/40 portfollio. He and his wife will each have maximum social security benefits at age 70, and they will also have a sizable taxable portfolio of $1.6K+ at age 72. We also expect the tax rates to increase in the future. Thanks for your insights.