There are two main types of individual retirement arrangements (IRAs): traditional and Roth. A traditional IRA defers taxes until you withdraw the funds. If you have a Roth IRA, you pay taxes on the funds when you make your annual contribution, and don't pay any further taxes. For some individuals, it makes sense to move your traditional IRA over to a Roth IRA; this is called a rollover or conversion. There's no limit on the amount of money you can rollover, or the number of times you can complete a rollover. The only limitation is your tolerance for paperwork.
Both traditional and Roth IRAs defer taxes, which means that as long as funds are in the IRA, you don't have to pay taxes on the growth. IRAs can contain stocks, bonds, mutual funds or certificates of deposit; the term IRA refers to its tax treatment, not the type of investment in the account. IRAs must be funded by money that you earn; you can't use funds from a retirement pension, for example, as an IRA contribution.
Converting a traditional IRA to a Roth IRA involves paying taxes on the growth of your IRA. The advantage is that you won't have taxes withheld when you take IRA distributions in the future. The disadvantage, of course, is that you pay the taxes the tax year you do the conversion. If you're under age 59 1/2, you should pay the taxes out of your own funds, and not have the taxes taken out during the conversion. If you take out taxes from the IRA during conversion, it will be treated as an early withdrawal, and you will incur the 10 percent early withdrawal penalty, in addition to the other taxes due.
You can completely rollover your traditional IRA or rollover a portion of your traditional IRA into a Roth IRA. For example, if you have a traditional IRA with $50,000, you can convert it to a Roth IRA all at once, moving all $50,000, or just part of it. If you want to spread out the taxes due, you can convert it over months or years.
How to Convert Your Traditional IRA
To convert your traditional IRA to a Roth IRA, contact the company that's holding your IRA. Let them know that you're interested in an IRA conversion, and you'd like to know your options. You can enroll a portion of your traditional IRA to a Roth, and you can roll your traditional IRA into multiple Roth IRA accounts. Your investment company can provide you with several options. You can also contact other companies for information on their Roth IRA options. If you work with an accountant or other financial adviser, you should consult him as well.
It's critical that you don't withdraw money from your traditional IRA, then purchase a Roth IRA, especially if you're under age 59 1/2. If you do, it will be taxed as a withdrawal and you could incur an early withdrawal penalty. Your traditional IRA funds should be sent directly to the new Roth IRA account or company. Once you've had the Roth IRA for five years, you can withdraw money at any time without penalty, regardless of your age.