Prior to 2010, your ability to convert funds to a Roth IRA was restricted by many things, including your tax filing status.  If you were married but filing separately, for example, you had to be separated from your spouse for an entire year in order to be eligible.  Now, however, there’s no longer a rule prohibiting people who are married but filing separately from converting their accounts.  If you have recently divorced or are in the process of filing for divorce, it makes sense to talk to a financial planner about saving for your retirement, as well as providing for any children or beneficiaries you may have.

Your adjusted gross income was also a factor in Roth IRA conversions before 2010; you weren’t eligible for a conversion if your modified adjusted gross income was more than $100,000.  As of 2010, this income limit no longer applies.  However, bear in mind that this repealed restriction applies only to Roth IRA conversions – traditional income restrictions still apply to future contributions made to Roth accounts.

In addition, while the IRS used to place limitations on the types of IRAs that could be converted into Roth IRAs, this has now changed – with a few exceptions.  A Simple IRA can be converted to a Roth IRA after you’ve been a participant in the Simple IRA for a minimum of two years, while designated Roth IRAs still cannot be converted to Roth IRAs.  Besides these two distinctions, your IRA should be eligible for rollover and/or conversion to a Roth IRA.

The most important thing to keep in mind when you’re considering a rollover IRA/Roth IRA conversion is taxes.  You see, the money in your IRA is money you’ve earned – either as income or interest – but that you haven’t yet paid any federal or state income tax.  Money in a Roth IRA, on the other hand, is money that has already been taxed.  This means that if you rollover your IRA into a Roth IRA or convert your IRA to a Roth IRA, you’ll have to pay taxes on the portion converted.

The fact that you’ll owe taxes if you rollover or convert your money to a Roth IRA was previously seen as a disadvantage by those who would otherwise be ideal candidates for Roth accounts.   However, many participants are beginning to seeing the advantage of paying taxes now, in anticipation of tax rate increases later in life.  There’s also the advantage of paying taxes now, rather than leaving that burden for the inheritors of your estate.  Your tax accountant or financial planner can help you to understand the tax implications of an IRA rollover/Roth conversion and to decide if it makes good financial sense for you.

In fact, any time you’re considering a Roth IRA rollover, it makes sense to meet with your tax accountant and financial planner and review your financial goals, particularly because IRA rollover questions usually arise when you’re changing jobs.  Any time you make a major financial change, it’s a good time to step back and reassess your retirement savings goals.

The main characteristic that sets Roth IRAs apart from other IRAs is that Roth IRAs are funded with income upon which you’ve already paid federal and state income tax.  Conversely, most IRAs are funded with income upon which you haven’t yet paid federal or state income tax.  This means that when you rollover to or convert to a Roth IRA, you will be expected to pay income tax on those funds.

The question of how much tax you’ll owe depends on a number of factors, including how much money is involved and what your current tax bracket is.  Bear in mind also that you aren’t required to convert the entire balance of your traditional IRA to a Roth IRA at once – you can convert as much or as little as you choose at a time.  If you have further questions about these requirements, check out the IRS website for more information or, better yet, speak with your personal financial adviser or tax accountant.  He or she can help you to determine exactly how much tax you’ll be required to pay.

Another legal change that takes place in the year 2010 is when the Roth IRA taxes you owe will be due.  If you roll over to or convert to a Roth IRA in 2010, you’ll pay half of the taxes due in 2011 and the remaining half in 2012.  This allows you to spread out the tax burden, which could be a real bonus if you’re considering rolling over or converting a significant amount of money.  Again, your personal financial adviser or tax accountant can help you determine not only exactly how much tax you’ll be required to pay, but also how that will affect your taxes for the years 2010, 2011 and 2012.

Another bit of good news – if you choose to rollover your IRA to a Roth IRA or convert your funds to a Roth IRA, you’ll probably avoid the mandatory withholding and/or penalties that you would have incurred had you chosen to just cash out your IRA.  If you do decide to cash out your IRA instead of performing a Roth IRA conversion, you’ll also lose out on the benefit of deferring the tax burden and spreading it out over two years.

As you can see, rolling your IRA over to a Roth account or converting your funds to a Roth IRA isn’t without its tax consequences.  However, those tax consequences are less of a burden now than they’ve been in years past, making it a perfect time to consider this change in your retirement savings strategy.  Paying the required taxes now, during your rollover or conversion, may also play an important role in your estate planning, as it will minimize the necessary taxes for those who receive any funds in the Roth IRA from your estate later in life.

Step 1 – Open a Roth IRA

If you’re at this point in the process, you’ve already rolled your old employer’s 401k or 403b retirement funds into an traditional rollover IRA account, which means you’ve already done the hard work of choosing an IRA account provider and moving your funds out of their original plans.

In most cases, you’ll want to open your Roth IRA account with the same provider that holds your rollover IRA.  This is the easiest course of action, although you may want to change providers if you’ve been unhappy with the customer service or investment options at your current provider.

Whether you decide to stick with your old provider or choose a new one, your first step in the Rollover IRA/Roth IRA conversion process is to open a Roth IRA account.  Typically, all you’ll need to do is fill out a form with your personal information – the provider will take care of the rest.

Step 2 – Fill out the Conversion Paperwork

If you decide to stay with the same IRA account provider, you’ll need to fill out a form they provide that details how the conversion will occur.  You’ll use this form to let the provider know how much of your funds should be converted and whether or not you’d like the provider to withhold any tax from the transfer.  You’ll likely need to have this document notarized and sign your name to indicate that you’ll be liable for the Roth IRA tax.

If you choose to open your account with a new provider, your paperwork may be a little more complicated, since you’ll need to transfer your funds between providers and from a traditional IRA to a Roth IRA.  However, it shouldn’t be that much more complicated than the documentation you completed to move your funds from the original 401k account to your rollover IRA.  If you have any questions, a customer service representative should be able to help walk you through the process.

Step 3 – Select Your Roth IRA Investments

Once you’ve completed the necessary paperwork, your provider will handle the rest of the transaction.  The Roth IRA transfer will take anywhere from a few hours to a week or two, depending on your provider.  After the funds have been deposited into your Roth IRA account, you’ll need to choose your investment options, just as you did with your 401k and rollover IRA accounts in the past.  A qualified financial advisor can assist you if you aren’t sure which options to choose.

In the future, when it comes time to pay taxes on your Roth IRA conversion, you’ll need to watch for mailed statements from your account provider.  Typically, you’ll receive a Form 1099R which shows how much money was converted to your Roth IRA.  This will need to be included on your annual income taxes; otherwise, you could face serious Roth IRA penalties.