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Contributions of Rollover IRA to a Roth IRA can always be withdrawn tax free.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.

When you hear the phrase “tax law changes,” you probably aren’t expecting good news.  However, if you’re considering a rollover IRA/Roth IRA conversion, these tax law changes may actually be to your advantage.

One of the biggest tax law changes in 2010, as far as traditional IRA/Roth IRA rollovers and conversions are concerned, is the ability to pay any Roth IRA tax incurred in 2010 during the conversion process in two parts.  To take advantage of this benefit, you report half of the amount converted during 2011 and pay taxes on it in that year, and then report the remaining half of the account balance during the 2012 tax year.  Spreading out the taxes over two years certainly helps to lessen the Roth IRA tax burden you’ll incur during the rollover/conversion process.

If for some reason the trustee of your current IRA is unable to perform a Roth IRA transfer, then the funds will have to be issued to you.  If this happens to you, understand that you have a limited amount of time to get that money into the target Roth IRA (typically 60 days, according to IRS statutes).  Fail to do so – even by one day – and the IRS will assume that you’ve simply withdrawn your money and will stick you with a variety of taxes and penalties.  For this reason, it’s a good idea to inquire about a direct rollover with both your current IRA trustee and your target Roth IRA trustee to make sure that this type of transaction can occur.

Here’s another tax consideration to make if you’re contemplating an IRA/Roth IRA conversion or rollover – where will you get the money to pay the taxes that are due?  Ideally, you’ll want to avoid using the money from your IRA to pay the taxes due, as this lessens the amount of money you have to invest.  Remember, you’re counting on these funds to grow over time to support you once you reach retirement age.

However, does it make sense for you to use money from your savings?  Will the money you lose in interest income by reducing the amount of your savings be offset by the gains of your money in the Roth IRA?  This is a question that deserves careful consideration.  Your tax accountant or financial adviser can help you put pencil to paper and come up with a real picture of just how much money is involved and how these decisions will impact your financial outlook, both in the short term and in the long term.

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.