If you’re looking at your rollover IRA, wondering how to turn this money into tax-free funds, you’re in luck. The IRS allows you to convert your IRA to a Roth IRA, growing it tax-free for retirement. You still have to leave the funds in the Roth until at least age 59 and 1/2, and keep the Roth IRA in place for five years before touching it, but if you can follow a few simple steps, you’ll be able to change over your IRA to a Roth fairly quickly.
Decide how much of the IRA you’d like to convert. You may decide that a partial IRA conversion to a Roth is a good idea, because you’re going to have to come up with money from outside of your IRA, to pay the tax on whatever you convert. Check your cash reserves to make sure you’ll have ample money to pay any taxes due before converting.
Calculate the tax you’ll owe on the conversion. Subtract any nondeductible IRA contributions from your current IRA value. Multiply this number by your federal tax rate and state tax rate. Add these two taxes together to find the total amount of tax you’ll pay on your conversion.
Open a Roth IRA that matches your goals. If you’re comfortable with your current trustee, it may be easiest to contact the company and tell them your plans. In many cases, they’ll walk you through the process and point you to the correct forms. If you wish to use a different company, ask the new company for the correct forms to set up a conversion Roth IRA and to transfer your assets.
Complete paperwork with your new IRA trustee to transfer your rollover IRA to your Roth. This avoids the IRS rollover rules that penalize you if you hold onto IRA funds for longer than 60 days. If you’d like to keep the same investments, use an account transfer form to transfer your existing funds to your new account. For new investments, ask your IRA trustee about back-end fees before selling your investment.
File the correct tax forms at tax time. File form 8606 at tax time to claim your rollover IRA conversion. Complete the top of the form and skip to Part II, “Conversions From Traditional, SEP, or SIMPLE IRAs to Roth IRAs.” Enter the amount you converted on line 16, and the amount you contributed and didn’t deduct on line 17. Subtract line 17 from line 16 on line 18 and include this amount on Form 1040, line 15b; Form 1040A, line 11b; or Form 1040NR line 16b. (resource 8606)
- Roth IRA conversion rules change often. Visit the IRS.gov website and type "Roth IRA conversion" into the search box in the upper right corner for any new developments.
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