If you’ve ever wondered how you could turn your tax-deferred Traditional IRA contributions into a tax-free Roth IRA, you’re in luck. The IRS allows you to convert your Traditional IRA to a Roth IRA so you may grow it tax-free for retirement. The funds must stay in the Roth IRA until at least age 59 and 1/2, and the new Roth dollars must stay in the account for at least 5 years before touching it. If you can follow a few simple rules, you’ll be able to convert your Traditional IRA to a Roth IRA.
Determine how much of your Traditional IRA you’ll be able to convert to a Roth. You’re going to have to pay tax on whatever amount you choose, and these funds will have to come from outside of your IRA to avoid taxes and penalties. Check your bank accounts to see how much cash you’ll be able to dedicate toward the conversion.
Determine the tax you’ll owe when you convert. Subtract any IRA contributions you didn’t deduct from the current value of your IRA. Multiply the difference by your federal and state tax rates. Add these taxes together to calculate the total tax bill that will be due upon your Traditional to Roth IRA conversion.
Open a new Roth IRA to hold your converted funds. If you're happy with your current IRA trustee, call the company and tell them you wish to convert your Traditional IRA to a Roth. In most cases, the company will help guide you to the appropriate forms and walk you through the conversion. If you’ve decided to switch to a new IRA provider, call the new company and ask them for guidance. They’ll help with forms to transfer the funds and open your Roth IRA.
Complete forms with your Roth IRA company to transfer your Traditional IRA to your new Roth IRA. This paperwork helps you avoid an IRS penalty applied to individuals holding onto IRA funds longer than 60 days. If you’d like to use the same investments in your Roth that you had in your Traditional IRA, ask for an account transfer form to send the existing funds to your new account without selling. If you decide to sell your investments, check with your existing IRA trustee about back-end investment fees before pressing the “sell” button.
File the appropriate IRS tax forms. At tax time, you’ll need to file form 8606 to show the IRS your Traditional IRA conversion. Fill out the top of the form and skip to Part II, “Conversions From Traditional, SEP, or SIMPLE IRAs to Roth IRAs.” Write the amount converted on line 16, the amount contributed and not deducted on line 17. Subtract line 17 from line 16 and write the difference on line 18. Include the line 18 amount on Form 1040, line 15b; Form 1040A, line 11b; or Form 1040NR, line 16b.