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Contributions of Rollover IRA to a Roth IRA can always be withdrawn tax free.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

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.

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.

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.

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.

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.