Converting Vanguard Non-Deducted IRA to Roth - Should I Withhold Taxes?

Converting non-deducted IRA contributions to a Roth is actually a smart move! Here's what you should know about the tax withholding question: Since you've already paid taxes on the original $3,500 contribution, you're right that you'll only owe taxes on the $450 in earnings. When it comes to withholding, this is really a personal preference rather than a requirement. If you don't withhold now, you'll need to pay any taxes due when you file your return next year. Vanguard will send you a 1099-R that will show the full conversion amount, but it will also code it properly so the IRS knows you had basis in the IRA. You'll need to file Form 8606 with your tax return to document the non-deductible contributions, which ensures you're only taxed on the earnings portion. Most people choose not to withhold if they can afford to pay the tax later, since this allows you to convert the full amount, maximizing what goes into the Roth to grow tax-free.

I went through this exact situation last year with my Vanguard account. I decided against withholding during the conversion and just made sure I had enough set aside to pay the tax bill when filing. Check out https://taxr.ai if you want to calculate exactly how the conversion will impact your taxes. It analyzed all my documents and showed me precisely what I'd owe on just the earnings portion of my conversion. The tool was super helpful because it also flagged that I needed to file Form 8606 for previous years when I made the non-deductible contributions (which I had totally forgotten to do). Definitely saved me from potentially paying taxes twice on the same money.

Just wanted to update about my experience using taxr.ai for my Vanguard Roth conversion. I was skeptical at first since I've used other tax tools that were confusing, but I'm glad I gave it a try. It correctly identified that with my other traditional IRA assets, I needed to use the pro-rata rule for calculating the taxable portion of my conversion. The service saved me from a major headache because I was going to just report taxes on the gains portion, but it turns out that's not how it works when you have other pre-tax IRA funds. The analysis showed I'd owe more than I expected, but at least I wasn't surprised at tax time! They also generated the exact forms I needed to file.

If you're trying to get answers about Roth conversions directly from the IRS, good luck getting through to them. After spending hours on hold trying to clarify how to handle my own conversion last year, I discovered https://claimyr.com through a YouTube video (https://youtu.be/_kiP6q8DX5c). They actually got me a callback from the IRS in about 20 minutes instead of waiting on hold all day. The IRS agent confirmed that I should NOT withhold taxes during the conversion since the tax would only be on the earnings portion, and it was such a small amount that it wouldn't trigger any underpayment penalties. Plus, they gave me specific instructions on how to properly document everything on my return.

I have to eat my words about Claimyr. After my skeptical comment, I decided to try it for myself because I had questions about my Roth conversion that I couldn't get answered anywhere else. I figured it was worth a shot since I'd already wasted so much time trying to reach the IRS. It actually worked! Got a call back from an IRS agent in about 45 minutes. The agent confirmed that I should file Form 8606 for both the year I made non-deductible contributions AND the year I did the conversion. They also explained that withholding isn't necessary for small earnings amounts like mine, but if I wanted to be safe I could make an estimated tax payment instead. Saved me hours of frustration and got me the exact information I needed.

One thing to consider about withholding on Roth conversions - if you choose to withhold, that amount is actually considered a distribution and doesn't get converted to the Roth. So if you're converting $3950 and choose to withhold 10% ($395), only $3555 actually gets converted to the Roth. This is why most folks recommend not withholding during conversion but instead either increasing your withholding from your regular paychecks or making an estimated tax payment separately.

Has anyone done a Roth conversion with Vanguard specifically? Is there anything unusual about their process compared to other brokerages? I need to do this too but I'm nervous about messing something up.

Great question! I went through this exact same scenario with Vanguard about 6 months ago. You're absolutely right that you only owe taxes on the earnings portion ($450), not the original $3,500 you already paid taxes on. I chose not to withhold taxes during the conversion for a couple reasons: First, as others mentioned, any amount withheld reduces what actually gets converted to your Roth. Second, since the taxable amount is relatively small, it's unlikely to cause underpayment penalties if your regular withholding from work covers most of your tax liability. Just make sure you keep good records of your non-deductible contributions. Vanguard will send you a 1099-R showing the conversion, but you'll need to file Form 8606 to prove to the IRS that you already paid taxes on the original contributions. If you haven't filed Form 8606 in previous years when you made those non-deductible contributions, you should consider filing amended returns to establish your basis properly. The conversion itself is pretty painless through Vanguard's website - just be prepared for several confirmation screens asking if you understand the tax implications!