While most people are familiar with traditional and Roth IRAs, there is also a third type of retirement account known as a nondeductible IRA. A nondeductible IRA is similar to a traditional IRA, with the exception that contributions are not tax-deductible. Depending on your financial situation, it may be to your benefit to consider converting your nondeductible IRA to a Roth IRA.
Step 1
Obtain a current account statement from your nondeductible IRA. Determine the current value of your account and what portion of the funds you wish to convert. You may choose to convert some or all of the money in your account, and you also need to make sure that you have enough money to cover any potential tax liability.
Step 2
Calculate your estimated tax penalty for conversion. When you convert any IRA to a Roth IRA, you are required to report the distribution from your nondeductible IRA as income on your taxes. This means that any funds you withdraw for the purpose of converting to a Roth IRA will be taxed at your current tax bracket. Using your prior year's income tax return or current income statements, you can determine your estimated tax liability based on the IRS Tax Table.
Step 3
Establish your target Roth IRA if you haven't done so already. You may choose to set up your new Roth IRA with the same firm that holds your current nondeductible IRA or open an account at a separate financial institution. Make note of the new account number and the financial institution's complete contact information as you will need to provide this to the company who manages your nondeductible IRA.
Step 4
Contact the company that holds your nondeductible IRA to initiate your conversion. You may request that they send you a check for the amount of the funds in your account, or you can provide them with the account number and contact information for the institution that manages your Roth IRA. If you opt to receive a paper check, you must deposit that money into your Roth IRA within sixty days to avoid a ten percent early withdrawal penalty.
Step 5
Complete and return any paperwork required for the conversion. The transfer of funds may take up to six weeks to complete, depending on which financial institutions you're dealing with. Once the transfer is complete, you will need to fill out new forms for beneficiaries for the new Roth IRA. When you file your taxes, you will need to report the distribution as income.
Tips and Warnings
- Speak with a certified financial planner prior to initiating a conversion to ensure that you will benefit from doing so.
- Determine if you will have the funds on hand to pay any withdrawal penalties or tax liability prior to executing your conversion. If you use converted funds to pay the regular income tax penalty, you may also be hit with a ten percent early withdrawal penalty.
Things You'll Need
- Recent IRA account statement
- IRA distribution forms
- New Roth IRA account
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