How to Convert a Traditional IRA to a Roth IRA

IRA's are a way to save on your own toward your retirement. There are two major types of IRA's, the traditional IRA and the Roth IRA. The main distinguishing difference is that with the traditional IRA, the money invested is pre-tax income, whereas if you invest in a Roth IRA you are using income that you already paid taxes on for the year. Many people decide to convert their traditional IRA's to Roth IRA's. The decision is based on a few factors, such as the tax bracket one has now compared to what it will be at retirement. This article will explore how to convert a traditional IRA to a Roth IRA and what considerations to factor in the decision.

Difficulty: Moderate

Instructions

Things You'll Need:

• current investment in a traditional ira
• adjusted gross income of less than $100k per year
• not married filing separately on your taxes
• place to invest in the roth ira (could be same investment that traditional ira is in)

1. Determine that you meet the requirements to convert from a traditional IRA to a Roth IRA in the current tax year. To do this, you must have an adjusted gross income of less than $100,000, and you must not be married filing separately.

2. Determine that you can afford to pay the taxes on the amount you convert. The amount you take out of the traditional IRA will be considered ordinary income on your taxes this year, and you will have to pay the taxes on this income. The only exception would be nondeductible contributions made to your traditional IRA. If you can't afford it, wait until another year. You would end up using part of the IRA to pay your taxes, and the money you don't reinvest will be subject to the 10% penalty tax on early distributions.

3. Compare your tax bracket now to what you expect it to be at retirement. If you have a low tax bracket now and expect it to be high then, you will gain a benefit by transferring to the Roth IRA.

4. Consider other factors and decide that the conversion is the right choice for you. One factor would be the amount of time you have until you will start withdrawing funds. You want a 10 to 12 year period so you can recoup the amount you lost to taxes this year when you made the conversion. Also consider that you have to wait for five years to take out the money from the Roth IRA without penalties.

5. Find out the details of your current traditional IRA. You need to know where you have the money invested, such as with American Funds or T Rowe Price, and what type of investment you have, such as in mutual funds or bonds.

6. Determine where you will invest in the Roth IRA and what type of investment it will be. The easiest thing to do is just convert the same investment from a traditional IRA to a Roth IRA. So, if you have a traditional IRA investment in T Rowe Price's Retirement 2040 fund, just convert that same investment.

7. Make the conversion. To do this with the same investment, you just contact the company and let them know you wish to convert to a Roth IRA from your traditional IRA. You will generally have to fill out a conversion form. If you are going to make a new investment, you will have to let the old company know, and then have the new company set up the new account for you. You will have to generally fill out a conversion form and an IRA transfer form. Be prepared to get a statement at the end of the year considering your conversion as ordinary income which must be reported on your taxes.

Tips & Warnings

• The sooner you convert your traditional IRA to a Roth IRA, the longer you have to make tax-free earnings.
• If you convert your traditional IRA to a Roth IRA, you don't have to pay the penalties for early distribution. This is an exception to the general rule.
• One advantage to converting to a Roth IRA is that once you have the money invested in the Roth IRA for five years, there are certain exceptions to waiting for retirement that allow you to withdraw your money without penalties.
• Even without waiting five years, you can always take out the amount of your contribution without any penalties.
• An additional advantage of a Roth IRA is that you don't have to start taking distributions when you reach age 70.5 as you do with a traditional IRA.
• If you are about to retire and use your funds, it may not give you much benefit to transfer from a traditional IRA to a Roth IRA.

Resources

• Ehow Article on Roth IRA Distribution Rules
• Ehow Article on Roth IRA Withdraw Rules
• Ehow Article on Investing in Roth IRA
• IRS Publication 590 on IRA's (Online Version)

[grouch]

on 2/8/2009 Lots of people plan for retirement but only sum check the whole tax side out. Thanks for the helpful advice.