Trad IRA rollover to Roth with no earned income?

[sornord]

I'm a 63-year-old Federal annuitant. No earned income, just my monthly annuity. Florida resident since 2002. I have questions concerning a rollover from a Trad IRA into a Roth but get contradictory answers, even from H&R Block.

I have a Traditional IRA valued (today anyway) at $71k-ish. Down significantly with the current coronavirus impact, BUT, good time to take it out due reduced taxes. Want to remove some of the funds (but not enough to push me from the 22% to 24% bracket), pay the 20-22% tax, and put the remaining funds directly into a new Roth IRA, hoping to score some bargains while the markets are down. I'm setting up the new Roth with the same company holding the Trad. IRA. I have had an existing Roth IRA with another financial company for well over 5 years but do NOT plan to move it to the new Roth I'm setting up.

1. Is this transfer permissible if I have no earned income?
2. What will the applied "income" figure be for my 2020 return, the pre-tax or post-tax figure? I calculate I'm safely able to increase my income about $30k without adversely affecting my tax bracket. (about $85K starts the 24% bracket.)
3. The Trad. IRA holder says they will not withhold taxes (unlike my TSP, who take out 20% from Trad TSP disbursements). Can I send a check for the 20-22% taxes into the IRS toward my 2020 taxes now, or do I have to hold it until I file my 2020 return?
4. I'm told the NEW Roth will not be subject to the 5-year requirement since I already have one that meets it. Please confirm.

 

[adjusterjack]

I have a Traditional IRA valued (today anyway) at $71k-ish. Want to remove some of the funds (but not enough to push me from the 22% to 24% bracket), pay the 20-22% tax, and put the remaining funds directly into a new Roth IRA, I'm setting up the new Roth with the same company holding the Trad. IRA. I have had an existing Roth IRA with another financial company for well over 5 years but do NOT plan to move it to the new Roth I'm setting up.

Having done exactly what you are contemplating, I can answer your questions with some accuracy.

1. Is this transfer permissible if I have no earned income?

Yes. It's called a "conversion" and is addressed in IRS publication 590-A starting on Page 44:

https://www.irs.gov/pub/irs-pdf/p590a.pdf

2. What will the applied "income" figure be for my 2020 return, the pre-tax or post-tax figure?

You can transfer any amount from the traditional IRA to the new Roth. That amount will be taxable income, added to your other taxable income. Look at the 2019 1040 to get an idea what that looks like. On your 2020 tax return you put the amount of the conversion (distribution) on line 4a and the same amount on 4b (assuming the lines are numbered the same).

https://www.irs.gov/pub/irs-pdf/f1040.pdf

3. The Trad. IRA holder says they will not withhold taxes (unlike my TSP, who take out 20% from Trad TSP disbursements). Can I send a check for the 20-22% taxes into the IRS toward my 2020 taxes now, or do I have to hold it until I file my 2020 return?

Actually, in both the traditional IRA and your TSP you might have the option of having taxes withheld or not. If not, then you might want to consider paying quarterly estimated tax. Likely be a lot less painful spreading it out over 4 payments. Keep in mind that the first installment is due April 15 so if you are going to make your transfer, do it before then so you have the advantage of 4 payments.

Read the following from the IRS about Estimated Tax:

https://www.irs.gov/pub/irs-pdf/f1040es.pdf

4. I'm told the NEW Roth will not be subject to the 5-year requirement since I already have one that meets it. Please confirm.

That is, unfortunately, 100% wrong. Each annual conversion has to remain in the account for its own 5 year period for the earnings to be tax free. Each calendar year counts. Example:

2020 conversion must remain in 2020, 2021, 2022, 2023, 2024.
2021 conversion must remain in 2021, 2022, 2023, 2024, 2025
2022 conversion must remain in 2022, 2023, 2024, 2025, 2026

You get the idea.

The IRS publications don't give any examples like that but it's addressed on page 28 of Publ 590-B "Additional Tax on Early Distributions."

https://www.irs.gov/pub/irs-pdf/p590b.pdf

It's very confusing but I long ago confirmed the above example with Taxing Matters, a tax attorney who participates here.

If I have missed anything or have been unclear, Taxing Matters will add clarity.

 

[sornord]

You have provided more info in one afternoon than I was able to obtain in about a month of searching online and emails! THANK YOU SO MUCH!

You can transfer any amount from the traditional IRA to the new Roth. That amount will be taxable income, added to your other taxable income. Look at the 2019 1040 to get an idea what that looks like. On your 2020 tax return you put the amount of the conversion (distribution) on line 4a and the same amount on 4b (assuming the lines are numbered the same).

My rough calculation says to have $30k to put into the Roth, I'd actually have to take out $38k to have $30k after 22% taxes are withheld. The taxable income reported would be the whole $38k? (From which, I'd have to allocate the apx $8k for taxes, per the next question.)

I think I've answered my own question...Looking at my 2019 return (prepared but not filed) I took some cash out of a Trad IRA last year and killed some CC debt piled up from emergency travel over the last two years. The 1099-R showed the gross distribution (i.e. the pre-tax total I took out) and taxes withheld in separate fields...and I had to use the gross distribution on my return. (By lucky coincidence the upcoming stimulus check based on my 2018 return will be within a couple of hundred of the 2019 tax bill resulting from that Trad. IRA distribution.)

Actually, in both the traditional IRA and your TSP you might have the option of having taxes withheld or not. If not, then you might want to consider paying quarterly estimated tax. Likely be a lot less painful spreading it out over 4 payments. Keep in mind that the first installment is due April 15 so if you are going to make your transfer, do it before then so you have the advantage of 4 payments.

Quarterly payments over 2020, i.e. THIS year, or after I file the 2020 return circa April 2021? Either way I'd have to sequester and allocate the $8k or so of the distribution for those payments.

That is, unfortunately, 100% wrong. Each annual conversion has to remain in the account for its own 5 year period for the earnings to be tax free. Each calendar year counts.

Would that apply if I put the money into the EXISTING Roth - held at least 11 years - vice the new one?

 

[Taxing Matters]

Keep in mind that the first installment is due April 15 so if you are going to make your transfer, do it before then so you have the advantage of 4 payments.

Not so this year. Due to the corona virus relief notice issued by IRS and Treasury, the due date for the 2020 estimated tax payment that would ordinarily be due April 15 is now July 15. See IRS Notice 2020-18.

Each annual conversion has to remain in the account for its own 5 year period for the earnings to be tax free. Each calendar year counts.

Correct.

It's very confusing but I long ago confirmed the above example with Taxing Matters, a tax attorney who participates here.

You have a good memory on that, I'd forgotten it.

My rough calculation says to have $30k to put into the Roth, I'd actually have to take out $38k to have $30k after 22% taxes are withheld. The taxable income reported would be the whole $38k? (From which, I'd have to allocate the apx $8k for taxes, per the next question.)

In that case your distribution is $38K, and unless you have an extraordinary situation that entire 38K is taxable income to you in the year you get the distribution. So that's the amount you'd use to figure what estimated taxes to pay.

Quarterly payments over 2020, i.e. THIS year, or after I file the 2020 return circa April 2021?

You need to have sufficient amounts paid in either withholding or with estimated tax payments to cover most of the tax you will owe for the tax year. Thus, for 2020, if you don't have enough withholding, you need to make estimated tax payments in 2020 so that by January 15 you have most of your tax already paid. Normally the estimated tax payments are due April 15, June 15, September 15, and then January 15 of the next year. But due to corona virus relief, this year the April 15 estimated tax payment is now due July 15. That gives us a weird estimated tax schedule for 2020 of June 15, July 15, September 15, and then January 15, 2021 for the last one. Apart from the corona virus relief, the information on what to do for estimated payments is found in IRS Form 1040 ES.

Note that you need to also look at the rules for your state, too, if it has an income tax. The estimated payment dates may be different. In particular, not all states are providing the same corona virus relief.

 

[adjusterjack]

Would that apply if I put the money into the EXISTING Roth - held at least 11 years - vice the new one?

There's really no tax advantage to setting up a new Roth account, just keep careful records of your contributions and conversions. The tax results would be the same even if you put the new conversions into the existing account. It would be something else if the new Roth account had broader investment possibilities than the old one. Up to you.

I used my original Roth for my conversions. The five year period for the original Roth was long since up when I started converting my traditional IRA into the same Roth.

The IRS uses the "first in, first out" method. The money converted is always first in, first out. Earnings are always last out.

 

[sornord]

There's really no tax advantage to setting up a new Roth account, just keep careful records of your contributions and conversions. The tax results would be the same even if you put the new conversions into the existing account. It would be something else if the new Roth account had broader investment possibilities than the old one. Up to you.

I used my original Roth for my conversions. The five year period for the original Roth was long since up when I started converting my traditional IRA into the same Roth.

The IRS uses the "first in, first out" method. The money converted is always first in, first out. Earnings are always last out.

So the, let's say, $30K, from the Trad IRA under this scenario would still have to stay in the existing Roth for five years? And I presume as long as I don't take any distributions, I can move it between investments/brokerages.

 

[LdiJ]

I'm a 63-year-old Federal annuitant. No earned income, just my monthly annuity. Florida resident since 2002. I have questions concerning a rollover from a Trad IRA into a Roth but get contradictory answers, even from H&R Block.

I have a Traditional IRA valued (today anyway) at $71k-ish. Down significantly with the current coronavirus impact, BUT, good time to take it out due reduced taxes. Want to remove some of the funds (but not enough to push me from the 22% to 24% bracket), pay the 20-22% tax, and put the remaining funds directly into a new Roth IRA, hoping to score some bargains while the markets are down. I'm setting up the new Roth with the same company holding the Trad. IRA. I have had an existing Roth IRA with another financial company for well over 5 years but do NOT plan to move it to the new Roth I'm setting up.

1. Is this transfer permissible if I have no earned income?

A rollover does not require that you have earned income.

2. What will the applied "income" figure be for my 2020 return, the pre-tax or post-tax figure? I calculate I'm safely able to increase my income about $30k without adversely affecting my tax bracket. (about $85K starts the 24% bracket.)

I don't understand what you mean by "applied income"

3. The Trad. IRA holder says they will not withhold taxes (unlike my TSP, who take out 20% from Trad TSP disbursements). Can I send a check for the 20-22% taxes into the IRS toward my 2020 taxes now, or do I have to hold it until I file my 2020 return?

Did they give you a reason for refusing to withhold taxes? In any case, yes, you can send in an estimated tax payment towards your 2020 taxes You want to send in the estimated payment in the same quarter where you make the transaction.

4. I'm told the NEW Roth will not be subject to the 5-year requirement since I already have one that meets it. Please confirm.

You wouldn't have a penalty anyway because you are over 59 1/2, so the 5 year rule wouldn't apply to you anyway.

 

[adjusterjack]

A rollover does not require that you have earned income.

OP's talking about a conversion from Traditional IRA to Roth, not a rollover.

You wouldn't have a penalty anyway because you are over 59 1/2, so the 5 year rule wouldn't apply to you anyway.

To be clear, the 10% penalty would not apply but the conversion Roth earnings would be taxable if withdrawn before the 5 years are up.

So the, let's say, $30K, from the Trad IRA under this scenario would still have to stay in the existing Roth for five years?

It's the earnings that have to remain in the account for 5 years to become tax free. You conversion money can always be withdrawn because you have already paid tax on it. Example: you put $30K in the Roth in 2020. You earn $5K on it this year. You can take the $30K back with no tax (or leave it) but the $5K has to remain until the end of 2024 and then becomes tax free. If you convert another $30K in 2021, the earnings for that conversion have to remain until the end of 2025 and then becomes tax free.

And I presume as long as I don't take any distributions, I can move it between investments/brokerages.

Between investments, yes, easy. But between brokerages you would have to set up a new Roth with the new brokerages and do a roll over from one Roth to another. Example: You have a Roth with TDAmeritrade. You can invest in whatever TDAmeritrade has to offer (stocks, bonds, CDs, options, etc) but if you wanted Schwab to handle your money you would need a new Roth account with Schwab and would roll over funds from the other Roth. A roll over from Roth to Roth is not a taxable event.

 

[sornord]

This thread, and you guys, have been invaluable. Again, there is more good info here in a few days than I've been able to find in the past month!

 

[sornord]

FOLLOW UP:

I attempted to cash out $28,000 from a Traditional IRA. (I can safely take a $28k distribution without pushing myself into a higher tax bracket.) My intention was to put $22k of that into the Roth, and use the remainder to pay the estimated taxes on the distribution. The broker (who does not withhold taxes) said they could only transfer the entire amount - the whole $28k - into the Roth, leaving me to come up with $6k in taxes from my day-to-day money: a non-starter on our fixed income, even with estimated payments for the remainder of the year. The CSR said, confusingly, that I'd have to take out additional funds to pay the taxes, which would incur another tax requirement, ad infinitum.

The questions:

Is it permissible to use a portion of the distribution/conversion to pay the taxes, or must the entire amount, i.e. the whole $28k, be put into the Roth?

My calculations on IRS form 8606 lead to a taxable amount of $23,464, with just under $5,200 as 22% (my bracket) in taxes. I was ballparking $6k, so this was expected. I presume the directions from IRS form 1040-ES will be how I pay the $5,200 toward my 2020 taxes. If I'm correct in my reading, I have 60 days from the date of the distribution to put the money into the Roth.

How do I indicate to the brokerage holding the Roth that the funds I want to contribute to the Roth (via transfer from a personal, external bank account) are a conversion from a Traditional IRA, since (as noted before) I have no earned income?

Is this all on a "trust me" basis or is there some sort of IRS documentation I need to have?

Thank you all again....

 

[LdiJ]

FOLLOW UP:

I attempted to cash out $28,000 from a Traditional IRA. (I can safely take a $28k distribution without pushing myself into a higher tax bracket.) My intention was to put $22k of that into the Roth, and use the remainder to pay the estimated taxes on the distribution. The broker (who does not withhold taxes) said they could only transfer the entire amount - the whole $28k - into the Roth, leaving me to come up with $6k in taxes from my day-to-day money: a non-starter on our fixed income, even with estimated payments for the remainder of the year. The CSR said, confusingly, that I'd have to take out additional funds to pay the taxes, which would incur another tax requirement, ad infinitum.

The questions:

Is it permissible to use a portion of the distribution/conversion to pay the taxes, or must the entire amount, i.e. the whole $28k, be put into the Roth?

My calculations on IRS form 8606 lead to a taxable amount of $23,464, with just under $5,200 as 22% (my bracket) in taxes. I was ballparking $6k, so this was expected. I presume the directions from IRS form 1040-ES will be how I pay the $5,200 toward my 2020 taxes. If I'm correct in my reading, I have 60 days from the date of the distribution to put the money into the Roth.

How do I indicate to the brokerage holding the Roth that the funds I want to contribute to the Roth (via transfer from a personal, external bank account) are a conversion from a Traditional IRA, since (as noted before) I have no earned income?

Is this all on a "trust me" basis or is there some sort of IRS documentation I need to have?

Thank you all again....

Typically the Roth Conversions I have seen are trustee to trustee and the taxes are withheld from the distribution.

 

[adjusterjack]

The broker (who does not withhold taxes) said they could only transfer the entire amount

That bothers me. What happens when you have to start taking RMD (Required Minimum Distributions)? The broker would have to allow partial distributions. I suggest you go back to whatever paperwork you got when you opened the account and see if partial distributions are allowed or not.

Is it permissible to use a portion of the distribution/conversion to pay the taxes, or must the entire amount, i.e. the whole $28k, be put into the Roth?

Keep in mind that if you make the conversion now you don't have to file the return until next year and you can make estimated payments in smaller amounts while you save up the difference. Even if you miscalculate and underwithold the penalty won't be painful.

How do I indicate to the brokerage holding the Roth that the funds I want to contribute to the Roth (via transfer from a personal, external bank account) are a conversion from a Traditional IRA, since (as noted before) I have no earned income?

You don't. As far as the broker (and the IRS) is concerned it's a taxable distribution of the full amount. Doesn't matter if the check is made out to you or it's a direct transfer.

Though you are better off with a direct transfer for documentation. When next year rolls around you'll either owe a little, break even or get a refund.

Methinks you are overthinking this.

 

[FlyingRon]

Eh, I think it does matter how this is handled. Yes he is 63. Taking the money out isn't a problem. It's taxed the same either way. The problem is that he wants to put more money into a Roth than the contribution limit, but there isn't any limit on conversions. I have no idea why the person holding the existing IRA thinks a partial conversion is a problem. As far as the tax code is concerned it IS NOT.

 

[sornord]

That bothers me. What happens when you have to start taking RMD (Required Minimum Distributions)? The broker would have to allow partial distributions. I suggest you go back to whatever paperwork you got when you opened the account and see if partial distributions are allowed or not.



Keep in mind that if you make the conversion now you don't have to file the return until next year and you can make estimated payments in smaller amounts while you save up the difference. Even if you miscalculate and underwithold the penalty won't be painful.



You don't. As far as the broker (and the IRS) is concerned it's a taxable distribution of the full amount. Doesn't matter if the check is made out to you or it's a direct transfer.

Though you are better off with a direct transfer for documentation. When next year rolls around you'll either owe a little, break even or get a refund.

Methinks you are overthinking this.

The brokerage in question is SOFI, and they said they are not equipped "yet" to handle tax withholdings. Though that it implies it will change, it is the first time I've ever encountered that at any brokerage. If they don't withhold taxes...ever...then it looks like I'd be on my own to pay my taxes on any RMD. Beginning to rethink using them for these accounts...They only have my Trad IRA (which has taken significant hits on paper in recent weeks) and a currently-unfunded Roth.

 

[sornord]

Methinks you are overthinking this.

Perhaps I am - I'm noted for that - but overthinking is free...UNDERthinking might cost me a few thousand.