Roth IRA Conversion Explained

by Cynthia Myers

Roth IRAs allow your retirement savings to grow tax free. You pay taxes on the money the year you deposit it, but you don't pay taxes on your withdrawals in retirement. Come retirement age, or beforehand under certain circumstances, you can withdraw your contributions and the earnings tax-free. If you have a traditional IRA for your retirement savings, you have the option of converting these funds to a Roth IRA.


If you take a distribution from a traditional IRA you can roll it over into a Roth IRA, as long as you make the rollover within 60 days of receiving the distribution. Simply deposit the money into your Roth IRA account and indicate that the funds are a rollover from a traditional IRA. Or request your financial institution handle the rollover for you by depositing the funds directly into your Roth IRA account.


Ask your financial institution to transfer the funds from your traditional IRA to a Roth IRA at the same institution, or at another institution of your choosing. Your financial representative can assist you in opening the Roth account. As with a traditional IRA, you can choose from many investment options for your Roth account.


You must pay taxes on any previously untaxed funds in your traditional IRA that you transfer to a Roth IRA. Add the amount of these funds to your adjusted gross income on your taxes. You may need to convert funds slowly, over a period of years, in order to avoid a heavy tax burden. In 2010, special legislation allowed taxpayers to convert traditional IRAs to Roth IRAs and pay the resulting tax in 2011 and 2012, but this may or may not be extended for other tax years. You'll need to report your IRA conversion on tax Form 8606 -- Nondeductible IRAs.

Pros and Cons

Whether or not you'll benefit from converting your traditional IRA to a Roth depends on your age and your tax bracket. Younger workers, who have many years for their money to grow before retirement, stand to reap the biggest benefit in the form of tax-free earnings on their investment. Workers who expect to be in a higher or equal tax bracket upon retirement can also realize tax savings with a Roth. If you're close to retirement age and anticipate falling into a lower tax bracket upon retirement, making the switch might not benefit you if overall tax rates remain the same.