Roth Conversions and Withdrawals

Roth Conversions and Withdrawals are the two lists that realize income on purpose. Everything else that moves money out of an account is either required, such as RMDs and SEPP payments, or automatic, such as the selling that covers a shortfall. Both lists run at step 9 of the year, after income, expenses, and required payments, so a tax-targeted entry sees the year’s settled income (how a year works). Withdrawals turn into cash. Conversions move money from a pre-tax account into a Roth account and only their tax touches cash. FinZot can also search for a better set of these rules and write them into the scenario for you (conversion and withdrawal optimizer).

The three withdrawal kinds

Kind	Draws from	What the proceeds do
Pre-tax Withdrawal	Traditional IRAs, 401(k)s, 403(b)s, 457(b)s, including inherited ones	Ordinary income. Cash pays the year’s taxes first, then spending, and any surplus follows the Extra Cash Allocation Order.
Taxable Withdrawal	Brokerage accounts	Realized gains are taxed. Which holdings and lots are sold follows the sell strategy and any gain or loss limits (allocation, lots, and selling).
Roth & HSA Withdrawal	Roth accounts, HSAs, and 529s	Tax and penalty follow the account’s qualification rules (contributions, Roth basis, and the 5-year rule, account types).

A pre-tax withdrawal is the main tool for draining an inherited IRA. A Roth & HSA withdrawal is the only way to take money out of an HSA or 529 other than a qualified expense.

Where a withdrawal draws from

Every withdrawal names a source.

• Specific accounts, drawn in the order you list them.
• A whole group. Every pre-tax account, or every brokerage account, or every Roth account plus converted balances. A group picks up accounts you add later. The Roth group excludes HSAs and 529s, which you name directly, and it only supports As needed sizing.
• Converted balances. Only the Roth accounts FinZot creates for conversions, oldest first. Those accounts have no entry of their own, so this source or the Roth group is how you reach them.

The three ways to size a withdrawal

Fixed amounts. You set the amount. It can be a specific dollar figure, in today’s dollars or nominal dollars, with an optional growth rate on top of inflation. It can also be a percent of the source balance, a percent of free cash, a formula, or a phased schedule that changes over the years. A fixed withdrawal is committed before anything else in the year is sized.

Tax-targeted. You set an income target instead of an amount. FinZot sizes the withdrawal mid-year against the year’s settled income and fills up to the target. The targets are:

• the top of a federal tax bracket, such as through the 22% bracket
• the top of a state tax bracket
• an IRMAA tier, so the year’s MAGI stays under that Medicare surcharge threshold
• an FPL multiple, so the year’s MAGI stays under an ACA subsidy threshold

You can set more than one target. Each is a ceiling, and the withdrawal sizes to the lowest. You can add a dollar cap, and the Spending shortfall cap, which also never draws more than the year’s remaining spending need. A taxable withdrawal has no federal bracket target, because a brokerage sale’s income is a capital gain and skips the ordinary brackets. It can still target a state bracket, since most states tax gains as ordinary income. Roth & HSA withdrawals have no tax-targeted option, because a qualified withdrawal adds no income to fill against.

When a target cannot be reached, for example a state bracket target in a state with no income tax, the withdrawal reports that instead of failing. For each tax-targeted entry in each year, FinZot reports which ceiling set the size.

As needed. You set no amount. The withdrawal waits until step 10, after every fixed and tax-targeted entry has run, and covers whatever spending is still unfunded, in list order, until its sources run out or its per-year cap binds. This is how you say what to spend first. It is the only kind that can pay the tax a conversion created in the same year, because it runs after the conversion is sized. How as-needed entries fit with the proportional split and the last-resort sequence is covered under covering a shortfall.

Roth Conversions

A conversion moves money from a pre-tax account you own into a Roth account. Inherited accounts cannot be converted. FinZot creates a new Roth conversion account for each source account in each year, and it copies the source’s target allocation (contributions, Roth basis, and the 5-year rule). The reason for a separate account is explained in How FinZot Models Roth Conversions.

A conversion is sized like a withdrawal, Fixed amounts or Tax-targeted, with the same targets. It has no As needed option and cannot use the Spending shortfall cap, because it raises no cash.

The tax

The full amount converts. Nothing is withheld, so a conversion sized to a bracket or an IRMAA tier puts that whole amount into the Roth. The tax joins the year’s bill and is paid like any other cost: from the year’s cash, or if the year ends short, by the same shortfall stages as everything else.

To choose which account pays, add an As needed withdrawal from it, such as a brokerage account. It runs after the conversion is sized, so it is the one entry that can fund the tax in the same year. If a conversion year shows an early-withdrawal penalty, that selling reached a pre-tax account before age 60. Point an As needed withdrawal elsewhere, or convert less.

FinZot has no conversion withholding rate on purpose. Withholding leaves less in the Roth for the same tax, and under 59½ the withheld part is a distribution, taxed and penalized. Converting the full amount avoids both.

The order entries run in

Conversions and withdrawals are two lists, but the year runs them in passes across both. Fixed withdrawals run first, then fixed conversions, then tax-targeted withdrawals, then tax-targeted conversions. As-needed withdrawals run last, at step 10. Within a pass, entries run in list order. Fixed amounts commit first so the tax-targeted fills see the income they added. Conversions run after withdrawals in each pass because a conversion uses cash without raising any, so it is sized against every cash-raiser already committed.

Every tax-targeted fill is sized against the tax bill the year actually settles to, not an estimate. A fill aimed at a bracket edge lands on that edge in the final numbers, after the gains from any shortfall selling and the extra Social Security that income makes taxable. That mechanism is covered under sizing matches the final bill.

Early withdrawal penalties

FinZot uses whole-year ages, so the 59½ test is met from the year the owner turns 60.

• Pre-tax accounts. A withdrawal before that year pays the 10% penalty. There is no penalty on RMDs, on inherited accounts, on an account with an active SEPP §72(t) schedule, or on a pre-tax 401(k) or 403(b) whose owner has claimed the Rule of 55 exemption. That exemption covers leaving the employer in or after the year the owner turns 55, and FinZot honors it from age 55 on age alone. Governmental 457(b), Roth 457(b), NQDC, and Top Hat 457(b) accounts are never penalized. Other legal exceptions, such as disability, medical expenses, or a first home, are not modeled.
• Roth accounts. Penalty depends on the account’s state that year: qualified, seasoned but under age, or unseasoned (contributions, Roth basis, and the 5-year rule). Past the year the owner turns 60 there is no penalty even on an unseasoned account. A Roth 457(b), or a Roth under an active SEPP schedule, skips the penalty at any age. None of these change the state: earnings withdrawn before the account is qualified are still ordinary income.
• HSAs. A non-medical withdrawal pays a 20% penalty on top of ordinary income tax. From the year after the owner turns 65 there is no penalty, and the withdrawal is taxed like a traditional IRA withdrawal.
• 529s. A non-qualified withdrawal pays a 10% penalty on the earnings share, plus ordinary income tax on that share.

A penalized account is skipped by as-needed withdrawals and by the proportional split, and reached only through the last-resort sequence. Naming it in an as-needed entry moves it last, not first. A fixed or tax-targeted withdrawal does the opposite. It draws the account you named and pays the penalty.

Required minimum distributions

RMDs are not entries in either list. FinZot takes them at step 3, before any withdrawal you schedule.

• They start at age 73 or 75, depending on birth year, from every pre-tax account you own.
• Each year’s RMD is the prior December 31 balance divided by the factor for the owner’s age in the IRS Uniform Lifetime table.
• An owner whose spouse is more than ten years younger uses the IRS Joint and Last Survivor table instead. That factor is larger, so the RMD is smaller. A 75-year-old with a 55-year-old spouse divides by 32.4 rather than 24.6.
• FinZot treats a living spouse as the sole beneficiary of every account. A spouse who dies during the year still counts for that year. From the next year the survivor uses the Uniform Lifetime table.
• You can defer the first year’s RMD to the following year, which then takes two. In the deferral year a QCD satisfies no RMD.
• An RMD already taken counts toward the Traditional group’s share of shortfall selling (covering a shortfall).
• A fixed withdrawal from the same account sells its full amount on top of the RMD. Ask for $100,000 from an IRA in a year with a $40,000 RMD and FinZot takes $140,000 out. This is deliberate. A fixed amount is how you draw an account down faster than its RMD alone.
• A tax-targeted withdrawal also sells its full amount. The RMD is part of the settled income FinZot sizes against. It has already narrowed the room left under the target.
• Inherited accounts follow their own schedule, covered in account types.

On a mid-year plan start, the first year has no prior December 31 balance to read. What FinZot uses instead is covered in plan start date.