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Roth IRA Conversions: How They Work

Yesterday, I introduced Roth IRA conversions and explained why there has been increased attention on them. Today, we'll look at how they work.

There are three ways to convert traditional IRAs to Roth IRAs:

  • Indirect Roth conversions occur when traditional IRA holders request and constructively receive distributions from their IRA and deposit the amount in a Roth IRA within 60 days. In this situation, the check is made payable to the traditional IRA holder.
  • Direct Roth conversions occur when traditional IRA holders directly move their IRA assets to the receiving Roth IRAs without taking constructive receipt of the assets. In this scenario, checks are made payable to the receiving financial institutions for the benefit of the Roth IRA and forwarded as soon as administratively feasible to the receiving financial institutions.
  • Investors can convert their traditional IRAs to Roth IRAs by simply redesignating the traditional IRAs as Roth IRAs, provided the transaction is completed with the same trustee, custodian or issuer. Redesignating traditional IRAs as Roth IRAs, though physically accomplished via a transfer, is treated as a distribution and subsequent qualified rollover contribution.
In each of these cases, the tax law allows for transfer of assets other than cash to the Roth IRA provided that they are the same assets they received from the traditional IRA. It should be noted that the first method involves the most risk, as missing the 60-day deadline would result in the receipt of the check for conversion being treated as a distribution.

Tomorrow, we'll look at some important considerations to keep in mind regarding Roth IRA conversions.

Follow the series: Roth IRA Conversions