Traditional Individual Retirement Accounts (IRAs) are funded with earned (before-tax) income, deferring taxes on contributions and earnings. As long as the money sits in the IRA, no tax consequence is triggered. For those who don't need the supplemental income during retirement years, converting the traditional IRA into a Roth IRA is a consideration for estate planning purposes. At age 70 1/2, traditional IRA owners must start taking Required Minimum Distributions each year. While converting the asset to a Roth requires an immediate tax hit, the benefits of selecting a beneficiary IRA are getting tax-free distributions and continued growth.
Calculate the taxes you would pay on the Roth conversion by adding the total converted amount to your annual gross income. Look at the Internal Revenue Service (IRS) tax bracket for the income and multiply the rate by the converted amount. IRS conversion regulations in 2010 allow you to split the converted amount among 2010 and 2011 filing years.
Look for assets that will pay the tax bill. Using the IRA funds to pay the taxes erodes the growth potential of the account, diminishing the ultimate benefits of conversion.
Call your IRA custodian and request a conversion form. Some custodians will require new account paperwork while others only need the conversion form. Complete the form and submit it.
Obtain Form 1099-R that states the distributed and taxable amounts. The form is sent in January of the year following the conversion. Box 2a states the taxable amount that is recorded on Line 15 of IRS Form 1040. If you are splitting the taxes over two years, divide the taxable amount by two and list half on 2010 Form 1040 and half on 2011 Form 1040.
Beneficiaries must take the first distribution from an inherited IRA by December 31 in the year following the death of the IRA owner to stretch the IRA over his lifetime. Failure to take this distribution places the IRA on a five-year distribution liquidation schedule.