Why Your Roth Conversion Could Trigger an IRS Penalty? | The Limitless Retirement Podcast | The Limitless Retirement Podcast

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Danny Gudorf breaks down the complexities of Roth conversions, warning about the IRS pitfalls and penalties that can occur without proper planning. He highlights key advantages—tax-free growth and no required minimum distributions—and shares practical strategies like using the safe harbor rule and adjusting tax withholding to prevent underpayment penalties. Timing, he stresses, is essential for maximizing retirement tax efficiency.

Why Your Roth Conversion Could Trigger an IRS Penalty?

How a perfectly timed tax move can still cost you thousands—and how to protect yourself before it’s too late.

If you’re thinking about doing a Roth conversion this year, there’s a hidden trap that catches even the most diligent savers off guard.

You could pay every dollar you owe by December 31st and still get hit with an IRS underpayment penalty.

Yes, even if you “did everything right.”

I’ve seen it happen countless times—clients who carefully convert their IRA to a Roth, pay the taxes in full, and months later find a penalty notice sitting in their mailbox.

The problem? It’s not how much you pay.
It’s when you pay.

In this article, we’ll unpack:

  • Why the IRS penalizes you even if you pay on time

  • The three proven strategies to avoid this penalty

  • A simple checklist to protect your Roth conversion from unnecessary costs

Understanding What a Roth Conversion Really Does

A Roth conversion is one of the most powerful tools for long-term tax-free growth.

When you convert money from a traditional IRA or 401(k) into a Roth IRA, you’re essentially trading taxes now for freedom later.

Here’s what that means:

  • You pay ordinary income tax on the amount you convert today.

  • Once the money is inside your Roth, it grows tax-free—forever.

  • You’ll never pay taxes on qualified withdrawals.

  • You’ll avoid Required Minimum Distributions (RMDs) in retirement.

That’s why so many people use Roth conversions to lock in today’s lower tax rates and protect themselves from future increases.

But there’s one catch most people don’t realize: timing matters.

The Hidden Timing Rule That Triggers IRS Penalties

The IRS doesn’t just care about how much tax you owe—it cares when you pay it.

They expect taxes to be paid throughout the year as you earn income. Employers handle this automatically by withholding taxes from each paycheck.

But when you do a Roth conversion late in the year, you create a timing mismatch.

Let’s say you convert $100,000 in December. You write a check to cover the full tax bill by year-end. Feels responsible, right?

Here’s the IRS’s perspective:

“You earned that income evenly over the entire year, so you should have been paying taxes on it back in April, June, and September.”

Even though you didn’t actually have that income yet, they treat it as if you did—and if you didn’t make those quarterly payments, they can assess an underpayment penalty.

Right now, that penalty runs about 7% annually, compounded quarterly.

So if you owe $20,000 in taxes on your conversion and didn’t pay enough throughout the year, you could owe hundreds—or even thousands—of dollars in penalties.

And yes, this penalty applies even if you paid every penny by December 31st.

A Real-World Example

A few years ago, a retired client of mine converted $150,000 in November.
He was careful, responsible, and proactive. He paid the full tax bill in December.

Then, in May, a letter arrived from the IRS:
Underpayment Penalty — $2,000 Due.

He was shocked.
He thought he’d done everything right.

But because his conversion happened late in the year and he didn’t make prior estimated payments, the IRS considered him “late” even though he technically paid on time.

How to Avoid the Roth Conversion Penalty Trap

There are three main strategies to keep your Roth conversion penalty-free.

1. Use the Safe Harbor Rule

The safe harbor rule is the IRS’s way of saying:

“If you pay enough, we won’t penalize you.”

You can qualify for safe harbor in two ways:

  • Pay 100% of last year’s total tax liability through withholding or estimated payments, OR

  • If your adjusted gross income (AGI) is over $150,000, pay 110% of last year’s tax.

There’s also a second option:

  • Pay at least 90% of your current year’s total tax liability as you go.

If you meet either rule, you’re safe from penalties—no matter when your income arrives.

So before doing your Roth conversion, review last year’s tax return.
If you’re on track to pay 100% (or 110% for higher incomes) this year, you’re covered.

2. File IRS Form 2210 with Schedule AI

This one’s a little more technical—but it works beautifully.

Form 2210’s Schedule AI (Annualized Income) lets you explain to the IRS that your income didn’t come in evenly throughout the year.

It’s your chance to say:

“I didn’t earn this income in April or June, so I shouldn’t be penalized for not paying taxes on it then.”

The IRS will recalculate your required payments based on when the income actually occurred.

This strategy takes some extra paperwork, but it’s the most precise way to match your tax payments to your actual income timing.

3. Withhold Taxes Directly from Your IRA Conversion

This is the simplest option—and for many retirees, the most practical.

When you withhold taxes directly from your IRA or Roth conversion, the IRS treats those withheld funds as if they were paid evenly throughout the year.

That means if you withhold in December, the IRS still acts like you’ve been paying since January.

This completely eliminates the underpayment penalty.

Here’s the trade-off:
If you withhold taxes from your conversion, less money ends up in your Roth.

For example:

  • You convert $100,000

  • You owe $22,000 in taxes

  • If you withhold that $22,000, only $78,000 goes into your Roth

But if you pay taxes from a separate savings or brokerage account, the full $100,000 gets to grow tax-free—potentially earning you thousands more over time.

That’s why, whenever possible, I recommend paying taxes outside the IRA.
But if you don’t have that cash available, withholding is still the smarter move than risking penalties.

Advanced Tip: The 60-Day Rollover Workaround

If you want the best of both worlds, there’s a way—just be careful.

Let’s say you withhold taxes from your conversion to satisfy the IRS.
You can then replace that withheld amount within 60 days using money from your savings account.

Here’s how it looks:

  • Convert $100,000 from your IRA to a Roth

  • Withhold $22,000 for taxes

  • Within 60 days, move $22,000 from savings into your Roth

You’ve now restored your full $100,000 conversion amount, avoided the underpayment penalty, and kept the IRS happy.

This 60-day rollover strategy can be powerful, but it’s time-sensitive and easy to mishandle.
If you’re under age 59½ and fail to replace the withheld funds, that portion can be treated as a taxable distribution and may be subject to a 10% early withdrawal penalty.

So, if you’re considering this, talk to a tax professional first.

Your Roth Conversion Penalty-Free Checklist

Before you move forward with a Roth conversion, make sure you can check these boxes:

✅ Safe Harbor Coverage:
You’re paying at least 100% of last year’s taxes (or 110% if income > $150k).

✅ Withholding Strategy:
If converting late in the year, consider withholding taxes from your IRA.

✅ Schedule AI Option:
If your income is irregular, plan to file Form 2210 with Schedule AI.

✅ Cash Flow Plan:
If possible, pay taxes from a non-IRA account to maximize Roth growth.

✅ Timing Awareness:
Don’t wait until December without a plan—penalties compound quarterly.

The Bottom Line

Roth conversions are one of the smartest long-term tax strategies available to retirees.

But the tax timing is just as critical as the tax amount.

Do it wrong, and you could face a painful underpayment penalty—essentially paying interest to the IRS for no reason.
Do it right, and you’ll enjoy more of your money growing tax-free for life.

The key is to plan ahead. Run the numbers early, understand your payment options, and coordinate your timing with your tax professional.

Because when it comes to Roth conversions, the IRS rewards preparation—and punishes procrastination.

Next Step: Protect Your Retirement Income from Hidden Taxes

Avoiding this penalty is just the start.

The next big opportunity for most retirees lies in optimizing your withdrawal strategy—deciding which accounts to draw from first and when.

Get this wrong, and you could pay thousands more in lifetime taxes.
Get it right, and you can unlock more income, flexibility, and freedom in retirement.

*This blog post is based on the insights shared by Gudorf Financial Group. For personalized advice tailored to your unique circumstances, always consult a financial, legal, or tax professional.*

Transcript: Prefer to Read — Click to Open

If you’re thinking about doing a Roth conversion this year, there’s a hidden trap that catches a lot of people off guard. You could pay every dollar you owe by December 31st and still get hit with an underpayment penalty from the IRS. I’ve seen this happen to clients who thought they did everything right. They converted their IRA to a Roth, paid the taxes on time, and then months later got a penalty notice in the mail. So in today’s video, I’m going to walk you through exactly how this happens, why the IRS penalizes you even when you pay on time, and most importantly, how to avoid this mistake so you can keep more of your hard-earned money.

I’m Danny Gudorf, founder of Gudorf Financial Group. For over 15 years, my team and I have helped people over 50 build enjoy a limitless retirement.

Let’s start with what a Roth conversion actually is. A Roth conversion is when you take money from your traditional IRA or your 401k and you move it into a Roth IRA. When you do that, you pay ordinary income taxes now on the amount you convert. But once that money is inside the Roth, it grows completely tax-free. You never pay taxes on it again. You don’t have required minimum distributions. And when you pull money out in retirement, it comes out tax-free. That’s why Roth conversions are such a powerful strategy. You’re locking in today’s tax rates and protecting yourself from future tax increases.

Now here’s what most people don’t realize. When you do a Roth conversion, you’re not just adding income to your tax return. You’re also triggering a timing issue with the IRS. The IRS expects you to pay taxes throughout the year as you earn income. They don’t want to wait until April 15th to get their money. That’s why employers withhold taxes from every paycheck. That’s why self-employed people make quarterly estimated tax payments. The IRS wants a steady flow of tax revenue all year long.

So here’s the problem. Let’s say you wait until December to do a big Roth conversion. Maybe you convert $100,000 from your IRA to your Roth. That’s a smart move for a lot of people. But the IRS looks at that conversion and says, “You earned $100,000 of income in December, but we’re going to treat it like you earned it evenly throughout the entire year.” So in their eyes, you should have been making tax payments back in April, June, and September. Even though you didn’t actually have that income yet. And if you didn’t make those payments, they can charge you an underpayment penalty.

Right now, the underpayment penalty is 7% annually. That resets every quarter. So if you owe $20,000 in taxes on your conversion and you didn’t pay enough throughout the year, you could owe hundreds or even thousands of dollars in penalties. And this penalty applies even if you write a check for the full tax bill on December 31st. You paid on time, but the IRS says you didn’t pay early enough.

I had a client a few years ago who did a $150,000 Roth conversion in November. He was retired, so he didn’t have any withholding from a paycheck. He paid the full tax bill in December from his savings account. He thought he was all set. Then in May, he got a letter from the IRS saying he owed an underpayment penalty of over $2,000. He was frustrated because he did everything he thought was right. But he didn’t know about this timing rule.

So how do you avoid this penalty? There are really three main strategies you can use. The first one is called the safe harbor rule. If you pay 100% of last year’s total tax liability through withholding or estimated payments, the IRS won’t penalize you. If your adjusted gross income is over $150,000, you need to pay 110% of last year’s tax. There’s also another version of the safe harbor rule. If you pay at least 90% of your current year’s total tax liability through withholding or estimates, you’re safe. So if you know you’re going to do a Roth conversion, you can look at last year’s tax return and make sure you’re paying at least that much this year. That protects you from penalties.

The second strategy is to file IRS Form 2210, specifically Schedule AI. This is a little more paperwork, but it works. Schedule AI lets you show the IRS that your income really did arrive later in the year. You’re basically saying, “I didn’t have this income in April or June, so I shouldn’t be penalized for not paying taxes on it back then.” The IRS will recalculate your required payments based on when you actually received the income. This strategy works, but it does require you to fill out extra forms when you file your taxes. Some people don’t want to deal with that hassle, so they use the third strategy instead.

The third strategy is to withhold taxes directly from your IRA when you do the conversion. Here’s why this works. When you withhold taxes from an IRA distribution or a Roth conversion, the IRS treats those withheld dollars as if they were paid evenly throughout the entire year. Even though the withholding happened in December, the IRS acts like you paid it in January, February, March, and so on. So if you withhold enough to cover your tax bill, you avoid the underpayment penalty completely.

Now I’ll be honest with you. Withholding from your IRA is not my favorite strategy. Here’s why. When you withhold taxes from your conversion, you’re shrinking the amount that actually makes it into your Roth. Let’s say you’re converting $100,000 and you’re in the 22% tax bracket. You owe $22,000 in taxes. If you withhold that $22,000 from the IRA, only $78,000 ends up in your Roth growing tax-free. But if you pay the taxes from a separate account, like a savings account or a taxable brokerage account, the full $100,000 goes into the Roth. That’s a big difference over time. You’re moving money from an account where you pay taxes on interest and dividends every year into an account where everything grows tax-free forever.

But here’s the thing. If you don’t have the cash to pay the taxes out of pocket, withholding is still a good option. It’s better to withhold and avoid the penalty than to get hit with a surprise bill from the IRS. And if you’re doing a conversion late in the year, withholding can be the simplest way to stay compliant. If you’re under age 59½ and you withhold taxes from the conversion and don’t replace those withheld funds within 60 days, that withheld amount is treated as a taxable distribution and may be subject to the 10% early-withdrawal penalty.

There’s also a more advanced strategy that some people use. If you have the money to pay the taxes out of pocket but you don’t want to deal with estimated payments or extra tax forms, you can withhold taxes on your conversion and then do a 60-day rollover. Here’s how it works. You convert $100,000 from your IRA to your Roth. You withhold $22,000 for taxes. That $22,000 goes to the IRS, so it’s considered a withdrawal, not a rollover. But within 60 days, you take $22,000 from your savings account and you deposit it into your Roth IRA. That’s called a 60-day rollover. If you do it correctly, no taxes are owed on that $22,000. You end up with the full $100,000 in your Roth, and the IRS is happy because you withheld taxes. This strategy works, but it’s more complex. The general once-per-12-month limit on 60-day IRA-to-IRA rollovers does not apply to rollovers from a traditional IRA to a Roth IRA (conversions). So if you’re thinking about this, talk to a tax professional first.

Here’s the checklist I would follow if you’re planning a Roth conversion. First, check if you’re covered under the safe harbor rules. Look at last year’s tax return. If you’re paying 100% of last year’s tax liability this year, or 110% if your income was over $150,000, you’re protected. You can do your conversion whenever you want and you won’t owe a penalty. If you’re not covered by safe harbor, you have a few options. You can do the conversion in the fourth quarter and withhold taxes from the IRA to avoid penalties. You can file Form 2210 with Schedule AI to show the IRS that your income came in later in the year. Or you can make quarterly estimated tax payments throughout the year. Personally, I think quarterly payments create more work than necessary. There’s more room for mistakes. But it’s not a terrible option if you want to spread out your tax payments.

The bottom line is this. Roth conversions are one of the most powerful strategies you can use in retirement. But the timing and the tax handling matter just as much as the amount you convert. Do it wrong and you risk penalties. Do it right and you get more money growing tax-free for the rest of your life.

Now before you go, I want to make sure you’re not missing out on other tax planning opportunities. One of the biggest opportunities I see is optimizing your withdrawal strategy in retirement. Which accounts should you pull from first? Should you spend your IRA money early or let it grow? These decisions can save you tens of thousands of dollars over your lifetime. I created a video that walks through the exact withdrawal strategy that smart retirees use to keep more of their money. It’s called The Withdrawal Strategies Rich Retirees Use That Poor Retirees Don’t. Click on that video now to see how you can apply these strategies to your own plan. I’ll see you over there.

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