When you open a traditional Individual Retirement Account (IRA), you can deduct the money you contribute from your income taxes. These tax-free contributions may seem appealing, but you will have to pay tax on them later, when you begin to withdraw from the IRA. You also have to start taking money out of the IRA when you turn 70 1/2, or face penalties. Unlike the traditional IRA, with a Roth IRA, you do not receive the income tax deduction, but instead pay taxes on the money you contribute. However, when the time comes to take it out, you don't have to worry about paying taxes on it.
Contact the financial institution that manages your traditional IRA and let them know that you plan on rolling it over into a Roth. They can provide advice on whether or not doing so is a good idea and how to go about it.
Open a Roth IRA account at your financial institution. Fill out the application provided by your institution. You may be able to complete this process online.
Complete the paperwork needed to convert your traditional IRA to a Roth. The financial institution should provide the paperwork when you ask, or you may be able to find it on their website. Specify how much of the traditional IRA you want converted to a Roth IRA, whether you want the institution to withhold taxes for you and how you would like the assets re-invested.
Calculate the tax you will owe on the money you transferred to a Roth IRA. Multiply the amount you rolled over by the current tax rate. Depending on where you live, you may need to pay both federal and state income tax. If the current federal tax rate is 25 percent, and you rolled over $5,000, multiply 5,000 by 0.25. Include the amount of the money transferred to a Roth IRA on your income tax returns. As of 2010, you can spread the income tax you will owe on the converted IRA out over a period of two years, meaning you can claim half of it on your 2011 return and the other half on your 2012 return. You can also decide to pay it as one lump sum if you can afford it or if you worry that your taxes will increase considerably over the next two years.
- Try to avoid using funds from the converted IRA to pay the income tax as you'll be liable to pay the additional early withdrawal tax on those funds.
- Make sure the money from your traditional IRA reaches your Roth IRA within 60 days or you will need to pay a 10 percent early withdrawal penalty.