The Internal Revenue Service lets you convert money from a traditional IRA to a Roth IRA with a rollover. By converting, your future qualified distributions come out tax-free, which allows you to effectively lock in your current tax rate. In addition, you won't be required to take required minimum distributions from the Roth IRA.
No Compensation Requirement
If you wanted to contribute to a Roth IRA after you stopped working, you'd be out of luck because you didn't have any compensation income for the year. However, no similar requirement exists to convert money from a traditional IRA to a Roth IRA. As long as you're not required to take minimum distributions, you can roll over the entire value of your traditional IRA if you want.
Required Minimum Distributions
Starting in the year you turn 70 1/2 years old, you must start taking required minimum distributions from your traditional IRA. Since required minimum distributions aren't eligible for rollovers, you can't include that portion of the traditional IRA when figuring how much you can roll over to your Roth IRA. For example, say your traditional IRA is worth $300,000 and you're required to take out $20,000. You can only roll $280,000 to your Roth IRA.
Before you convert, consider the taxes you'll owe as a result of the conversion. You must pay taxes on the amount of the conversion that would have been counted as taxable income if you took a distribution instead. Unless you've made non-deductible contributions, this means the entire conversion is taxable. Depending on your other assets, you might not have the cash to pay the taxes.
Five-Year Waiting Period
You must wait at least five years after converting before you take out the conversion money without penalty -- unless you will reach 59 1/2 years old before five years are up. Even though the distribution isn't taxable because you paid takes on the distribution, you'll owe a 10 percent penalty. For example, say you convert $20,000 from a traditional IRA to a new Roth IRA in 2012 when you're 52 years old. If, in 2014, you take out $5,000, it won't be taxable but you will out the 10 percent penalty on the distribution.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."