As part of an ongoing series, Retirement Daily is posing a retirement-related question to the artificial intelligence large language models and then asking a subject matter expert to critique the answer. In this installment, we asked three AI models the following question:
Are taxes withheld on a Roth conversion for a person who is under 59 ½ years old?
Below are the responses from ChatGPT, Bard, and Perplexity, the most popular AI models in use today. The critique from Andy Ives, an IRA analyst with Ed Slott & Co., are below in bold.
Here are the answers we received:
ChatGPT
As of my last knowledge update in September 2021, taxes are generally withheld on Roth conversions for individuals who are under 59 ½ years old.
If taxes are withheld when under 59 1/2, it results in a 10% penalty on the amount withheld (assuming no other exception applies), so such a practice should be discouraged. To say taxes are “generally withheld” implies this is a proper strategy, which it 100% is not.
When you convert funds from a traditional IRA or a pre-tax retirement account to a Roth IRA, the converted amount is considered taxable income in the year of the conversion.
Correct.
The IRS requires that financial institutions withhold 20% of the taxable amount from the conversion for federal income taxes.
Totally false. The 20% mandatory withholding only applies to direct payments from a plan – like a 401(k) – to a participant of dollars that are eligible to be rolled over. It has nothing to do with Roth conversions.
This withholding is mandatory unless you opt for a direct trustee-to-trustee transfer, where the funds are transferred directly from one IRA custodian to another without you receiving the money in between.
It is true that 20% mandatory withholding on plan distributions can be avoided with a direct transfer, but this statement has nothing to do with Roth conversions.
However, it’s important to note that tax laws and regulations can change over time. Therefore, I recommend consulting with a qualified tax professional or financial advisor to get the most up-to-date and accurate information regarding Roth conversions and tax implications based on current tax laws in 2023.
This is the best statement ChatGPT could make – “Don’t trust me, see a qualified tax professional or financial advisor.”
Overall, ChatGPT gets an “F” grade for its response.
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Bard
Yes, taxes withheld on a Roth conversion for a person who is under 59 ½ years old are subject to a 10% penalty. This is because the withheld taxes are considered an early withdrawal from the traditional IRA, and early withdrawals are penalized unless an exception applies.
100% true and accurate.
For example, let’s say you are 35 years old and you have a traditional IRA worth $100,000. You decide to convert the entire IRA to a Roth IRA, and you have $20,000 withheld for taxes. The $20,000 that is withheld is considered an early withdrawal, and you will be penalized 10%, or $2,000.
Correct. (This example so closely mimics one of my recent articles that I would not be surprised if the algorithm pilfered my writing.)
There are a few exceptions to the early withdrawal penalty, but they are limited. For example, you can avoid the penalty if you are converting the IRA to pay for qualified education expenses, first-time homebuyer expenses or medical expenses that are not covered by insurance.
These two sentences are a confusing and erroneous mashup of two different rules. 10% penalty exceptions are for early withdrawals, not for Roth conversions.
If you are considering a Roth conversion, it is important to be aware of the early withdrawal penalty. If you are under 59 ½ years old, you should make sure that you have enough money on hand to pay the taxes due on the conversion without having to have them withheld from the IRA. This will help you avoid the 10% penalty.
Correct.
I give Bard a “B-” grade for this overall response.
Perplexity
According to the search results, taxes are not withheld on a Roth conversion for a person who is under 59 ½ years old.
Accurate, but a human being would have probably said, “Not typically withheld…” and mention why – because of the 10% penalty.
When you convert funds from a Traditional, SEP or SIMPLE IRA to a Roth IRA, the converted amount is treated as ordinary income and is subject to taxation.
True. However, there is no additional 10% tax on the amount converted.
It’s important to note that if you choose to have taxes withheld from the conversion, the custodian or its delegate is required to withhold 10% of the conversion amount for federal income taxes unless you elect not to have withholding.
Untrue. 10% is not required. A person can elect a custom percentage to be withheld.
This withholding is not specific to age but is a general requirement for federal income tax purposes.
Also true. Conversions can be done at any age without penalty.
To summarize, while taxes are not automatically withheld on a Roth conversion for individuals under 59 ½ years old, you have the option to elect to withhold if you prefer to have taxes withheld from the conversion amount.
True, but withholding taxes on a Roth conversion for a person under 59 ½ will result in a 10% penalty on the withheld amount (if no exception applies). This AI response fails to even mention the possibility of a penalty.
It’s recommended to consult with a tax professional or financial advisor for personalized advice regarding your specific situation.
100% agree.
Perplexity gets a “C” grade for this answer.
Points off for failure to address the 10% penalty concern.
Summary
Once again, these AI responses fail to hit the key points and oftentimes provide completely fabricated responses. If a person were to follow this guidance, there would surely be missteps and penalties to pay. AI has a long way to go before its responses can even be remotely trusted. My recommendation: disregard everything these three AI robots said… except for this one sentence from ChatGPT: “I recommend consulting with a qualified tax professional or financial advisor to get the most up-to-date and accurate information regarding Roth conversions and tax implications based on current tax laws in 2023.”
Editor’s note: Ives thinks “subject to penalty” should have been added to the end of the question posed to the AI models. Regardless, he said, the AI answers seem to have their own interpretation of the question.
You might also like:
Roth Conversion Confusion: Don’t Withhold Taxes If You’re Under 59 ½
ChatGPT vs. Expert: Why Not To Contribute to or Convert a Traditional IRA Into a Roth IRA
How To Convert a 529 Plan to a Roth IRA
