Not only are you permitted to rollover a qualified IRA plan distribution to another plan or to a traditional IRA, but you may also rollover the distribution to a Roth IRA. If you choose this option, however, you are technically converting the rollover IRA assets to a Roth IRA and all of the usual rules for Roth IRA conversions will apply. Specifically, you must be eligible to make the conversion in the first place. If you are, then you must pay income tax on all the pre-tax money that is transferred out of your employer’s plan into your Roth IRA. And you must pay it in the year of the conversion. There is one exception to this rule for conversion that takes place in the year 2010. You are permitted to spread the income from the IRA conversion over two years, beginning in 2011 (half in 2011 half in 2012). For conversions after 2010, however, all of the income from the rollover IRA conversion must be included on the tax return for year of conversion.

Who is Eligible?

For the year 2009, you are eligible to convert rollover IRA to a Roth IRA. If your modified AGI is $100,000 or less, and if you are married, you must file a joint return with spouse. (In other words, those who are married filling separately do not qualify to convert rollover IRA plan assets to a Roth IRA.) Beginning in 2010, everyone qualifies to converting rollover IRA to a Roth IRA.

Which Distributions Are Eligible?

As is the case with rollovers to other plans to traditional IRAs, all distributions and partial distributions from qualified IRA plans and qualified annuities are eligible to be rolled over to a Roth IRA, with the exception of required distributions and annuities or periodic payments that last for ten years or more.

Advantages and Disadvantages

Once you make the decision to roll over your employer’s plan into an IRA, the next question you must ask yourself is traditional IRA or Roth IRA? The decision involves a variety of factors. The beneficiary must first qualify to convert rollover IRA assets to a Roth IRA, the transfer from a qualified plan to a new Roth IRA must occur as a trustee-to-trustee transfer. The disadvantage of converting rollover IRA to a Roth IRA is that you must pay tax on the entire amount of the distribution right away.

The difference between your rollover IRA or Roth IRA is that instead of a tax deduction for your contribution, you get tax-free distributions later. It’s important to understand that if your tax rate stays the same, it doesn’t make a penny’s difference to your retirement income picture whether you use a traditional or Roth IRA rollover. Your net or after-tax income on withdrawals will be the same in either case.

If your tax rate goes up when you distribute your IRA rollover account later after retirement, you will be happy. Many believe that the current low tax rate is not sustainable—at least you wouldn’t want to be the farm that it is. Having an IRA rollover account for at least part of your retirement investments plan, hedges against possible tax increases later.

Another great use for a Roth IRA rollover is for young people who haven’t reached their full income potential. At low income tax rates, the value of the tax deduction given up by using a Roth IRA is negligible. Later, when they withdraw the funds tax-free that would have otherwise been taxed at a high rate, they will receive substantial tax benefits. In essence, they would have leveraged the tax code by the amount of the difference in their contribution and withdrawal tax rates. That’s very powerful. For instance, if you are in a 15% tax bracket now, the value of a $1,000 tax deduction is only $150. Let’s say that over time, your Roth IRA grows to $5,000. If you forgo the tax deduction and opt for the Roth IRA, when you take it out after retirement, you keep the entire $5,000 no matter how high your current tax bracket. If you had taken advantage of the Regular rollover IRA’s tax benefits, you would have saved $150, but you would be faced with tax on the entire $5,000 when you withdraw it. So the amount in your hands after tax would be far less.

Roth IRAs offer some benefits for your estate. In essence, you have prepaid the income tax on the entire amount for your heirs. The ability to stretch the tax-free distributions across at least two generations is very powerful. Additionally, there are no forced withdrawals at age 59.5. These advantages may or may not be an important issue for you, but it’s an added benefits.

Contributions of Rollover IRA to a Roth IRA can always be withdrawn tax free. But, the earnings must remain in the account until the account holder reaches age 59.5, or five years after deposit—whichever is later—to receive tax-free treatment.

The ability to withdraw contributions tax-free makes them a great way to accomplish multiple goals in a tax-preferred manner. Suppose, for example, after a number of years of contributions, you withdrew those contributions to fund your daughter’s college education while leaving the earnings to compound tax-free for your later retirement.

For a withdrawal from a Roth IRA to be considered qualified, meaning that you avoid taxes and penalties on the withdrawal, you must meet certain conditions.  A five-year aging requirement is imposed by the IRS, and you must meet one of three additional conditions – you must be at least 59 ½ years old, you must be making a first time home purchase, or there must be a disability or death to you or a dependent.  If you fail to meet these qualifications, taxes must be paid on the earnings withdrawn, in addition to a 10 percent additional tax penalty unless you qualify for an exception according to IRS rules.

While traditional IRAs require you to receive required minimum distributions (RMDs) beginning at age 70 ½, there’s no such requirement with Roth IRAs, except for Roth 401k plans.  As with a traditional IRA, you must begin receiving RMDs from a Roth 401k at age 70 ½ years.  As an additional precaution, be aware that contributions to a Roth 401k IRA cannot be moved to a regular 401k account, as you can’t “un-pay” taxes on the funds in your Roth account.

To continue to reap the benefits of your Roth IRA, consider carefully where and how any withdrawals will be used before they’re removed from your account.  As noted above, there are certain taxes and fees involved with a withdrawal which may make a rollover more advantageous.

Because of the nature of the funds in a Roth IRA, they can only be rolled over into another Roth IRA.  Generally, you would only move funds from one Roth IRA to another Roth IRA if the second offered you some advantage, such as increased earning potential, more control over your money or the ability to consolidate accounts under one provider or adviser, for example.

The rules surrounding Roth IRAs are a little different and a little more complex than traditional IRAs, especially with the legal changes that take effect in the 2010 tax year.  With this knowledge, you may want to consult a tax adviser or your financial planner before you make any decisions about moving money from one Roth IRA to another, or before you consider making a withdrawal.  There may be good reasons for either transaction, but you should confirm your decision with someone better versed in Roth IRA rules before you make decisions that could impact your future and that of your family.

Recently, though, the standards for Roth IRA conversion eligibility have changed.  Starting in 2010, there are no longer any income restrictions on those who are seeking a conversion.  If you have money in a traditional IRA, you can convert it into a Roth IRA, regardless of your household income.  Keep in mind, though, that these limits only apply to Roth IRA conversions – if your income is above certain guidelines, you won’t be able to contribute any additional funds to the account.

If you qualify for the Roth IRA rollover, you can distribute the entire balance of your traditional IRAs into the account without a problem.  The only thing that you’ll need to do is to ensure that you have the appropriate amount of taxes deducted from the IRA to cover your IRS needs – or enough funds on hand to pay your tax bill if you choose to convert the entire amount without withholding any money for taxes up front.

Of course, you might be wondering why anyone would want to open a Roth IRA if they’re just going to have to pay taxes on the amount that they transfer in.  The answer is that, since you don’t have to pay taxes again when the money is withdrawn, all of the earnings that come from a Roth IRA account are tax free.  For those who are worried that taxes are going to increase in the future, a Roth IRA rollover will allow them to invest with less stress.

To protect your 401k rollover to Roth IRA from unnecessary penalties, you’ll most likely want to go with a direct transfer to move your money between accounts.  This is a type of transfer that’s arranged directly between the banks, so that you never see a check for the balance of your account funds.  Doing it this way – instead of through an indirect transfer – will help to ensure that the proper amount for taxes will be withheld and that you won’t end up owing additional funds at the end of the year when you file your taxes.

So, if you’re interested in a Roth IRA distribution from your traditional IRA account and you meet the requirements described above, you should go to your financial advisor or your bank and set up a Roth IRA account.  After this is done, you can then have the bank complete the Roth IRA conversion from your existing account.  If you like, you can even ask them to withhold additional taxes, just to make sure that you’re adequately covered when it comes to taxes and the IRS.

Because of the tax dynamics involved, you can’t really do a Roth IRA/Traditional IRA rollover.  This is because when money is removed from a Roth IRA account it is not taxed since taxes were already taken out before the money was put into the account.  However, in a Traditional IRA account the money is taxed when it is removed because taxes were not withheld before money was put into the IRA.  This means that if you do a Roth IRA transfer to a Traditional IRA, then you will have to pay taxes on it again when it is withdrawn, and this is an unnecessary waste of money.

Something else to consider if you are doing a Roth IRA rollover is whether you are going to go through with an indirect or direct transfer.  In most scenarios you would want to go with the direct transfer, and this is probably also the case with the Roth IRA conversion.  When you do a direct transfer the money is moved between banking institutions and you do not have to worry about the handling of the money or the taxes because they are taken care of by the banks.  This will help to ensure that when you are converting to a Roth IRA from a Traditional IRA that the appropriate amount of taxes are withheld so that you do not end up with problems later.

In an indirect transfer the money from your existing IRA account is issued to you in the form of a check.  However, twenty percent of the total is withheld for taxes.  You then have sixty days to move the money into a qualifying account.  During this time you will want to open a Roth IRA account and make sure that you deposit the total check.  Then, the twenty percent is released for taxes, and if necessary additional taxes will be taken out of the Roth IRA to pay for the conversion.  This is a complicated and troubling process, and it can end up causing you a lot more stress than it would to just let the banks deal with it.  The upside is that it does allow you more of a hands-on approach.

If you are looking to make sure that your Roth IRA conversion goes well, you just have to follow a few simple rules and you can easily make a transfer from a Traditional IRA to a Roth IRA.

Because of this difference in how taxes are applied to the two types of IRA accounts, you’ll need to be prepared to pay taxes on the amount that you’re moving over if you’re contemplating a Roth IRA conversion.  This can be a confusing task, so to be sure that the IRA to Roth IRA conversion goes well; you’ll probably want to perform a direct transfer so that the bank is responsible for managing the withdrawal of the taxes.  If you’re confused by this, don’t be – it is important that you understand the difference between the two types of transfers so that you can choose the best option for your needs.

The direct transfer mentioned above is a type of transfer that occurs completely between banks.  With this type of Roth IRA conversion, you’ll need to establish the new Roth IRA account, but beyond this, the bank will initiate the transfer of money from your existing account into the new account and will take care of any taxes that need to be reported to the IRS.

The other type of 401k Roth IRA conversion is known as an indirect transfer, and it works a little differently.  In this case, the existing IRA account is closed and a check is issued to you for only 80% of the total balance (the other 20% is withheld for tax purposes).  You then have 60 days total to open the new Roth IRA and deposit the money.  In most cases, the 20% would then be released into the new IRA, but with a Roth IRA conversion, the rules are a little different, which can lead to confusion.

Because of this confusion, many people opt to not complete a Roth IRA transfer from their existing IRA, but rather opt to roll the IRA into another traditional IRA and then open up a separate Roth IRA account to receive new contributions.  This is a possibility, and it can alleviate some of the stress involved with Roth IRA taxes.  This way, the money that you’ve already have set aside in a tax-deferred account is left alone, and you’re free to make future deposits into the Roth IRA account.  Whichever way you choose to go, you’ll need to make sure that the taxes are handled properly, as mistakes here could cause problems later on.

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.

First consider the question of taxes.  If you move money from a traditional IRA to a Roth IRA conversion account, you will be required to pay taxes on the money coming out of the traditional IRA structure.  Your investment counselor or tax adviser can help you determine how much those taxes will be.  If you’re thinking about setting up a conversion account, you must consider whether or not you can afford those taxes at this time, as well as whether or not it’s worth it to perform the Roth IRA conversion.  There may be a more advantageous time for you to pay those taxes.

However, if the final tax bill your expect to receive as a result of your Roth IRA conversion scares you, don’t worry.  The new legislation described above offers you the opportunity to split up this tax burden over time in order to minimize your out-of-pocket expenses.  According to the new Roth IRA rules, the taxes you owe on any conversions made in 2010 can be broken up over the next two tax years.

It’s also important to consider the timing of your proposed Roth IRA conversion.  How long do you have before you anticipate beginning to make withdrawals?  The longer your money remains in the conversion account, the greater the benefits of making the conversion, generally speaking.  A minimum of five years is recommended by some financial counselors in order to make up the cost of the taxes you’ll owe.  Otherwise, you may want to consider another type of IRA, rather than a Roth IRA conversion.

In some cases, though, one of the best reasons to establish a Roth IRA conversion account is – strangely enough – the opportunity to pay taxes on your money now.  While most people anticipate being a lower tax bracket once they retire, that may not be the case for you.  If you anticipate being in a higher tax bracket upon retirement, it makes sense to set up your rollover account and pay those taxes now.  Or, if you plan to leave your savings to your beneficiaries or heirs, it may be advantageous to your estate to pay taxes now.  Again, these considerations can be complex, and are best made with the advice of a financial professional.

When you’re setting up your Roth IRA conversion account, make sure you understand all of the tax implications involved in your transfer.  If you’re ready to go ahead, your next step is to establish a Roth IRA with a provider who is well rated and provides excellent customer service.  Make sure the Roth IRA is set up so that it can receive the funds before initiating the rollover request. T o minimize any potential tax liabilities, penalties and withholding, talk with your Roth IRA account manager or trustee about performing a direct rollover or trustee to trustee transfer when moving your funds into the account.

First, you cannot rollover funds from a Roth IRA into a traditionally structured IRA – you can only roll them over to another Roth IRA.  If you think about it, this makes logical sense – one of the reasons to have a traditionally structured IRA is to defer taxes on that portion of your income, a benefit you’ve lost already if the money is in a Roth IRA.  You can rollover funds from one Roth IRA to another Roth IRA if there is a compelling reason to do so, such as an opportunity to improve your investment portfolio’s management or returns.

You can also rollover funds from a traditionally structured IRA into a Roth IRA, but there will usually be taxes to be paid.  Legislative changes for the 2010 tax year are making it more advantageous to have a Roth IRA conversion account.  However, before you change the way your investments are structured, it’s a good idea to review your short and long term financial plans with a tax or financial adviser.  It may be beneficial for some individuals to pay those taxes upfront and convert money into a Roth IRA, but not for all.  Professional advice can help you to be certain where you stand before you initiate such a transaction.

One advantage of Roth IRAs is that having already paid taxes on the money you contributed, there are generally no taxes paid on withdrawals so long as they are considered qualified withdrawals or distributions.  To be considered a qualified withdrawal, you must have been participating in the Roth IRA for a minimum of five years and you must be at least 59 ½ years old.  However, if you’re buying your first home, become disabled, or are using your Roth IRA money to pay for higher education, then your distribution may be considered qualified without meeting those two criteria.  Withdrawals or distributions that are deemed not qualified may be termed early withdrawals, upon which the IRS imposes a 10 percent tax penalty.

One rule you should be aware of is that if you attempt to rollover your funds to a Roth IRA and are unsuccessful for some reason, you may also be subject to early withdrawal penalties.  Generally, speaking with the trustee or manager of the target Roth IRA will ensure that the Roth IRA is ready and able to accept any rollovers.  In fact, not having an account which is ready and able to receive funds is one of the most common Roth IRA rollover mistakes.

There is a wealth of information regarding Roth IRA tax rules located on the IRS website.  You may also be able to find IRS publications at your local post office or public library.  If you need help understanding the rules surrounding Roth IRA accounts and rollovers, talk with your tax adviser or financial planner.  When it comes to your future and your money, it’s a step well worth taking.

So why wouldn’t you convert all of your traditional IRA holdings to Roth IRA accounts right away?  Well, there are a few catches, perhaps the most noticeable of which is that you’ll have to pay ordinary income taxes on any funds you convert to your Roth IRA rollover account.  Let’s look at a few situations in more detail to see where a rollover IRA to Roth IRA conversion makes sense for you:

Do you qualify for a conversion?

Great news – you do qualify, in light of recent IRS changes!  In the past, only account holders with an adjusted gross income (AGI) of less than $110,000 (single or head of household filers) or $160,000 (married couples) were eligible to contribute to Roth IRAs.  Now, however, even taxpayers with higher AGIs can convert funds to Roth accounts, provided they’re already in traditional IRAs.

Do you have the funds available for any applicable conversion taxes?

When you perform a Roth IRA conversion, you’ll be liable for income tax on any earnings or pre-tax contributions in your traditional IRA account, as you’ll have to claim the converted amount on your annual tax returns as income.  If you’ve only got a few thousand dollars socked away, this may be only a minor inconvenience, but if your traditional IRA account balance is much larger, you could be looking at several thousand dollars in tax penalties alone.

On the positive side, the recent IRS changes discussed above also offer some relief to taxpayers facing large tax penalties from Roth IRA conversions.  According to the new Roth IRA conversion 2010 rules, you’ll be able to spread your conversion over two tax years, lessening your tax burden significantly.

Another thing to consider when looking at Roth IRA conversion taxes is whether or not the added income will disqualify you from other federal and state tax benefits.  When you convert funds from your traditional IRA to a Roth IRA, you’ll receive a Form 1099R from your account provider.  Income entered from this statement is counted as general income on your tax return, causing your AGI to go up.  This increase may make you ineligible for other credits – such as child care or education programs – resulting in a net loss to you.

How close are you to retirement?

If you’re nearing retirement age, there are a few things you’ll want to consider before converting.  First of all, your traditional IRA balances are likely much larger than those who are just starting their retirement savings, which will lead to larger tax consequences, as discussed above.  Keep in mind that you’ll have less time to recoup these losses if you’re already close to retirement age.

Additionally, consider whether or not you expect your tax bracket to fall once you enter retirement.  If, for example, decreases in your AGI cause you to move from an effective tax rate of 28% to 15%, it makes no sense to pay taxes on these funds up front instead of later on when you begin taking distributions.