Personal Finance (Not Investing) • Roth conversion tax source

Yes, there are good, valid reasons to pay the taxes from your IRA (whether as part of the conversion or a separate transaction). In my case, I want/need to deplete my IRA as fast as possible, due to lower tax bracket space availability in the last couple and current year, which may not last. The pretax IRA by definition isn't all yours - taxes will be due when withdrawn, so it's just about when you pay those taxes. In my specific case, I do a large Roth conversion in January, withdraw some money to live on, and pay our taxes mid-December with a large IRA withdrawal 75% to the IRS, 24% to my Governor, and 1% to me (you can only withhold 99%). Considerations: tax bracket of heir (10 year payout), single survivor of MFJ loses half the bracket, spouse hits RMD age, when you start SS, low income year due to early retirement or sabbatical etc. I would not withdraw it just to stuff it in a taxable brokerage account, but Roth conversions and living expenses (or college, car, etc) are viable reasons.
Edit to add: My marginal tax bracket is 24% (plus a bit of IRMAA). if I die, my heir (prime working years) will pay 32~35% taxes on that money. Also, for some people, if you are in a high inheritance tax state, better to lower your net worth by paying taxes now vs your heirs paying inheritance taxes and plus income taxes! So, yes, it's all about tax arbitrage. Life is uncertain.

This decision has nothing to do with depleting your traditional IRA faster. It has to do with whether you end up with more money in your Roth IRA or in your taxable account at the end of the year.

Yes, I agree, if you pay taxes from a taxable account you end up with more in the Roth. However, most people dont have that kind of cash just sitting around, especially for a large conversion. And if you sell appreciated assets in your taxable account to pay the taxes you will likely pay capital gains taxes on the gains and possibly the additional NIIT taxes, plus you have to pay the estimated taxes in the quarter that you do the conversion, plus if you are married, you give up a future step up in basis on those assets when one of you passes (community property rules vary by state). I just pay the taxes from the IRA at the END of the year, which allows me to keep that money invested all that year. To me, this method (paying taxes from the IRA is simpler and close enough.

But if you have the cash in taxable, by all means you should use that cash to pay the taxes.

Your mileage may vary…

Step-up doesn't matter if the asset is in a Roth. And you don't have to worry about estimated taxes on your capital gains if you account for the taxes in your withholding calculation when you do your conversion.

Statistics: Posted by Fat Tails — Sat Jun 15, 2024 1:00 am — Replies 57 — Views 3525