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I have some money in a former employer's 401k program that I am in the process of rolling over to a Rollover (Traditional) IRA. My question is, if I decide to convert this into a Roth, and it gets taxed, does the tax money get taken out of the amount in the IRA, or do I just owe the taxes come tax time next year? Thanks!

Foolish Tom
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<<< I have some money in a former employer's 401k program that I am in the process of rolling over to a Rollover
(Traditional) IRA. My question is, if I decide to convert this into a Roth, and it gets taxed, does the tax money
get taken out of the amount in the IRA, or do I just owe the taxes come tax time next year? Thanks! >>>

While you may do this, I believe that the money used to pay tax will be considered as a withdrawal from the traditional IRA, and subject to any penalties that may apply.

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It shouldn't be penalized, because I am not withdrawing the money. What I'd be doing basically is converting a traditional to a Roth, and I wondered where the tax $$ comes from.

Foolish Tom
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I have some money in a former employer's 401k program that I am in the process of rolling over to a Rollover (Traditional) IRA. My question is, if I decide to convert this into a Roth, and it gets taxed, does the tax money get taken out of the amount in the IRA, or do I just owe the taxes come tax time next year?

****It would be best to have your former employer do a direct rollover so that no tax need be withheld. Should you take the funds first, your employer would have to withhold 20% for taxes. If you can't come up with that 20%, when you make the rollover to your new regular IRA, you would have to pay a 10% penalty tax, in addition to regular tax, on any amount you couldn't cover to make your plan whole. If you later rollover to a Roth, it would be best to pay the tax up front, out of your other funds, or (depending on the size of the rollover), make estimated tax payments throughout the year. Uncle Sam wants his money up front. If you have a sizeable tax that is going to be due, and don't pay it in the form of estimated tax payments or withholding tax, you could be charged a penalty for underpayment of tax.

Hope I have answered your question and it doesn't sound like babble. If it does, c'mon back 'n I'll try to do better!=:)

The money will not be taken out to pay the tax. If it were taken out of your distribution (and you couldn't replace it), you could be exposed to a penalty on that amount, and you would have to pay income tax on it as well. If you are going to pay the tax out of your own funds, make quarterly payments or have extra money withheld from your pay. Not doing so could expose you to a penalty for underpayment of taxes!

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I did exactly the same thing last year for two 401ks. You could pay the taxes for the Roth conversion, out of the IRA money, but I wouldn't do the conversion if I had to do it that way because of two things.

1. You will pay a 10% early withdrawal penalty on the money you pull out for taxes.

2. Probably most important, depending on your investment horizen, you take away dollars from your IRA which, after conversion, will grow not only tax deferred but tax free!

If at all possible, get the money together from non-qualified sources to pay the taxes and preserve the benefit of the IRA.

Tyler
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[[I have some money in a former employer's 401k program that I am in the
process of rolling over to a Rollover (Traditional) IRA.]]

Good deal...

[[ My question is, if I
decide to convert this into a Roth, and it gets taxed, does the tax money get
taken out of the amount in the IRA, or do I just owe the taxes come tax time
next year? Thanks!]]

It doesn't automatically come out of the IRA. You would have to make that decision. And if you do make that decision, you'll owe taxes and penalties on the difference.

If you don't have the funds elsewhere to pay the tax on the conversion, it is a strike against you when you consider moving from an IRA to a Roth. Let me give you an example...

Say that you have a $20k IRA (all taxable, let's say). Lets say also that you are in the 28% bracket.

Your conversion will cost you $5,600 in taxes. You decide that you don't have the funds availabe to pay these taxes, so you simply convert $14,400 to your Roth IRA, and remove the other $5,600 to pay the tax.

Not only has your Roth IRA investment base been depleted substantially, but you'll now owe PENALTIES on the $5,600 "early" distribution (assume that you are under age 59 1/2) to the tune of $560 (or 10% of the distribution not converted). So this could be a pretty heavy price to pay.

So you might want to give this a bit more consideration before moving on it. You can also read more about the Roth IRA (and the decision making process) in my series of posts on the Roth IRA in the Taxes FAQ area.

TMF Taxes
Roy

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[[It shouldn't be penalized, because I am not withdrawing the money.]]

You certainly are if you are using the funds to pay the taxes. Regardless of if the amount is taken from the regular IRA or the Roth IRA.

And even if the IRAs paid that money directly over to the IRS, it would STILL be determined an early distribution, subject to the penalties.

[[ What I'd be
doing basically is converting a traditional to a Roth, and I wondered where the
tax $$ comes from.]]

Hopefully, the tax dollars will come from another account that you have OTHER than the new Roth IRA or the old traditional IRA.

TMF Taxes
Roy
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[[ Hopefully, the tax dollars will come from another account that you have OTHER than the new Roth IRA or the old traditional IRA.

TMF Taxes
Roy ]]

Absolutely. I just wanted to make sure I could even do this. As long as I have the choice, I will pay the taxes from my own pocket. The rollover amount isn't very much, so it's not that much $$ in taxes I'd be paying. Thanks all of you for the info.

Foolish Tom
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