David McKnight addresses something that can make or break your Roth conversion strategy: how you actually pay the tax.
David kicks things off by sharing that Federal and state estimated tax payments are usually made in four equal installments: April 15th, June 15th, September 15th, and January 15th of the following year.
Did you know that doing a Roth conversion in December, like many people do, will lead to the IRS pretending that income was earned evenly throughout the year?
If you don’t account for that, you could get hit with an underpayment penalty (8% of the underpaid amount).
David goes over different ways you can handle the tax payment.
The first way is to pay it using cash or a taxable brokerage account – this allows the full conversion amount to move from IRA to Roth IRA.
By doing that, you’re essentially using your least efficient dollars, from a tax efficiency perspective, to catapult 100% of the converted amount into the Roth IRA.
David touches upon the IRS Form 2210 Schedule AI, which informs the IRS of the fact that your income was uneven and it can wipe out the penalty for the first three quarters of a year.
The second way is to withhold the tax at the time of conversion. While this method helps prevent the risk of penalty (and you don’t have to file extra forms) it comes with a downside: less money ends up in the Roth IRA.
Thirdly, you could make a second IRA distribution and withhold 100% for taxes.
David shares a word of caution: when using this approach, you don’t want to bump up into a higher tax bracket, especially if it’s a jump from the 24 to the dreaded 32% bracket.
Mentioned in this episode:
David’s national bestselling book: The Guru Gap: How America’s Financial Gurus Are Leading You Astray, and How to Get Back on Track
PowerOfZero.com (free video series)
@mcknightandco on Twitter
@davidcmcknight on Instagram
David McKnight on YouTube
Get David's Tax-free Tool Kit at taxfreetoolkit.com
