The BEST Way to Convert Your IRA to a Roth IRA

By Joe Cicchinelli, IRA Technical Expert

Follow Me on Twitter: @JoeCiccEdSlott

If you’re thinking about converting some or all of your IRAs to a Roth IRA, there are two ways to do it. The two ways are by taking an IRA distribution or by direct transfer. Regardless of which method you choose, it will be treated and reported as a distribution from your IRA and a conversion deposit into your Roth IRA. IRA-to-Roth IRA conversions are taxable to you as ordinary income, but no 10% penalty applies, even if you’re under age 59 ½.

If you take a distribution from your IRA, you can complete the conversion by depositing the funds into a Roth IRA within 60 days after you receive the IRA distribution. When the check is made payable to you personally, you have control of that money, but the problem with completing a conversion this way is that the 60-day clock is ticking. This 60-day clock is the same clock that is ticking when you do an IRA-to-IRA rollover.

There are lots of times when things go wrong during those 60 days and the funds don’t get deposited on time into the Roth IRA. For example, you might use the money to pay some bills but then you lose track of time and don’t complete the conversion within 60 days. If that happens, you’re no longer eligible to do the Roth conversion. In that case, your IRA distribution will be taxable to you, plus you will owe the 10% early distribution penalty if you’re under age 59½. To make things worse, you won’t get the benefit of tax-free buildup of investment gains in the Roth IRA either.

The better way to do an IRA-to-Roth IRA conversion is by direct transfer. In a direct transfer, you don’t have control of the money because the funds are sent directly from your IRA to your Roth IRA. You can convert your IRA to a Roth IRA via direct transfer with the same custodian that has your IRA or to a different custodian. Either way, by using the direct transfer method there is no 60-day clock ticking so you eliminate the possibility that something will go wrong during that time frame.

Note: Whenever you’re doing an IRA-to-Roth IRA conversion, always tell the Roth IRA custodian that it’s a conversion to make sure that they properly report it as a conversion on IRS Form 5498.

This article is part of Roth Conversion Week at The Slott Report. Come back all week long for insight and analysis on Roth conversions, the benefits of tax-free planning, the possible pitfalls involved and more. Click here to view all articles this week.