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Do a Roth conversion in November or December and you’ve made a smart move in a low-income year. You’ve also just bought yourself a tax problem.
The IRS wants its money as you go, not in one lump next April. And for estimated payments, it grades you quarter by quarter. Say you convert $100,000 in December and the conversion generates a tax bill in the low $20,000s. Pay it all with a single January estimated payment and you might think you’re square. You’re not. The IRS looks back and sees that it wanted roughly $5,500 in each of the four quarters, and the first three came up empty. That’s an underpayment penalty waiting to happen.
The fix isn’t another estimated payment. It’s withholding, and one rule makes it work.
Tax withheld is treated as paid evenly across all four quarters, no matter when you actually take it out. A single withholding event in December is spread back over the whole year in the IRS’s eyes. An estimated payment in December counts only for the quarter you make it.
That asymmetry is the whole game. So if you’re planning a fourth-quarter conversion, cover the tax through withholding, not a January check. A few clean levers:
One caution that trips people up: don’t withhold the tax from the Roth conversion itself. That money never reaches the Roth, and if you’re under 59½ it counts as a distribution and can trigger the 10% penalty. Convert the full amount. Source the tax from somewhere else.
One more thing worth knowing. If you’ve already paid in (through withholding plus timely estimates) at least 90% of this year’s tax, or 100% of last year’s, you’re in the safe harbor and owe no penalty regardless of timing. (The 100% rises to 110% if your prior-year AGI topped $150,000.) But a large Q4 conversion can blow past that cushion fast, which is exactly when the withholding trick earns its keep.
The broader payoff is peace of mind. Withholding lets you make a big fourth-quarter move without reconstructing your income quarter by quarter next April. You pay the same total tax. You just skip the penalty math and the Form 2210 headache.
Plan the conversion in the fourth quarter. Plan the withholding right alongside it.
I asked Gemini to develop a strategy for a large 4th quarter roth conversion and desire to treat taxes as a withholding and to take taxes from a brokerage account. After some back and forth arrived at the following. I would be interested if the tax gurus on HD see any fatal flaws?
There is one unique loophole if you absolutely want the payment to be classified by the IRS as a withholding rather than an estimated payment.
The IRS treats all retirement account tax withholdings as if they were paid evenly throughout the entire year, regardless of the actual date the withholding took place.
If you want to exploit this rule to completely bypass the need for filing Form 2210 Schedule AI at tax time, you can do a two-part transaction using both your retirement and brokerage accounts:
1. The Pure Conversion: Convert the desired amount from your Traditional IRA to your Roth IRA, selecting 0% withholding so the entire balance moves safely into the Roth.
2. The Tax-Withholding Distribution: Take a separate, deliberate distribution from your Traditional IRA directly to the IRS as a 100% tax withholding to cover the tax bill.
3. The Brokerage Backfill: Immediately use cash from your Schwab brokerage account to execute a 60-day rollover contribution to your Roth IRA to replace the amount you just distributed for taxes from your traditional IRA.
Why this works:
Because the IRS views the tax withheld in Step 2 as having been paid equally across Q1, Q2, Q3, and Q4, it automatically erases any underpayment penalties for the earlier quarters. By backfilling the Roth IRA with cash from your brokerage account within 60 days, you ensure that the total money distributed from your traditional IRA is converted to your Roth IRA, taxes are a withholding and in effect funded from your brokerage account.
Warning on the Loophole: You are only allowed one 60-day indirect rollover per 12-month period. If you have already executed an indirect rollover recently, you cannot use this method.
Hi Grant, and thanks for the article (John Urban) and this comment. Sorry to be a few months late commenting but I think your approach is very intriguing and I have questions for you if you have time to help me understand your process. Firstly, my situation is retired, no W2 income and RMDs to be satisfied from conventional IRA before the end of the year. Also, not yet concerned over IRMAA impact at this time.
Q1. The 1, 2, 3 process says one can do a rollover contribution to the Roth account with money from a regular brokerage or other non-IRA account within 60 days. Is this correct? I thought that a rollover should be IRA to IRA (Roth and/or conventional).
Q2. About the 1, 2, 3, process. Why not make the conversion and pay the taxes directly from the converting IRA at the same time. Brokerage will withhold the amount specified to make it a single operation on my part. THEN I take money from the non IRA account and rollover the amount withheld in taxes into the target Roth account. I realize this violates the guidance that taxes shouldn’t be withheld from a conversion, however, since the taxable amount is being deposited almost immediately back into the Roth account then it would seem to be a wash. What are your thoughts? Am I missing something?
Thanks, Derek
Grant – Thanks for the reply. If I understand your process correctly, my observation would be: The Step 2 distribution came out of a Traditional IRA. Roll it back into a Traditional within 60 days with brokerage cash and it’s a tax-free wash. Roll it into the Roth instead and it’s a Roth conversion, fully taxable, because you’ve moved Traditional money into a Roth.
So the “tax money” doesn’t pay the tax. It becomes an extra conversion equal to the tax, which means a $100,000 conversion you thought you did is actually $130,000.
And that overshoot is the whole risk: if you sized the $100k to stay under a bracket or IRMAA threshold, the real $130k blows through it.