How to Convert a Deferred Compensation Plan to a Roth IRA
Deferred compensation plans such as 401k, 403b and 457 plans are widely used to allow employees to supplement government retirement programs. These programs take pre-tax dollars that are granted tax-deferred status through a number of investment programs. This reduces the annual tax bill encouraging people to build a nest egg. Roth IRAs changed how people plan for retirement since a Roth allows you to grow assets in a tax-free vehicle.
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Instructions
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Determine if you qualify for a Roth conversion. While 2010 allows all income levels to convert, there IRS rules will revert to income limits for Roth conversions in 2011.
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Calculate how much of your deferred compensation plan you can rollover and later convert. It is wise to convert as much of your funds into a Roth before the assets grow too large. The more you convert, the more you pay in taxes. If you are still employed, your deferred compensation plan may have limits to how much can be rolled out of the plan while you are still employed. Contact your plan administrator for specific details.
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Rollover the assets you are allowed to from your deferred compensation plan into a Traditional IRA. Make sure the assets are deposited into the IRA within 60 days of liquidation from the deferred compensation plan to avoid tax penalties. Deferred compensation plans only allow money to be rolled into Traditional IRAs, not Roth IRAs.
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Request a trustee to trustee transfer from the Traditional IRA to a Roth IRA. While it is called a trustee to trustee transfer, it can be at the same institution with the same trustee. Your plan custodian will be able to provide you with the proper paperwork to ensure the conversion is completed properly.
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File Form 8606 with your income tax Form 1040. The conversion will generate a 1099R with the amount converted added to ordinary income. There are no penalties assessed for being under 59 1/2.
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Tips & Warnings
Once funds are converted to a Roth, you must hold the account for at least five years before taking distributions to avoid tax penalties.
References
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